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Courage to Capital? A Model of the Effects of Rating Agencies on Sovereign Debt Roll–over

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  • Galina Hale

Abstract

With the rise of international bond markets in the 1990s, the role of sovereign credit ratings has become increasingly important. In the aftermath of Asian Crises a series of empirical studies on the effects of sovereign ratings appeared. The theoretical literature on the topic, however, remains rather scarce. We propose a model of rating agencies that is an application of global game theory in which heterogeneous investors act strategically. The model is consistent with the main findings of the empirical literature. In particular, it is able to explain the independent effect of sovereign ratings on the cost of debt. Our model also predicts that, in addition to affecting the level of debt roll–over, the mere existence of the rating agency's announcement can increase the magnitude of the response of capital flows to changes in fundamentals. In addition, introducing a rating agency to a market that otherwise would have the unique equilibrium can bring multiple equilibria. The model also allows us to explore the reasons why agencies may over–react to crises, how they can spread financial contagion, and the failure of rating agencies to predict crises. Classification-F34, G14, G15

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Paper provided by IIIS in its series The Institute for International Integration Studies Discussion Paper Series with number iiisdp062.

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Date of creation: 20 Apr 2005
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Handle: RePEc:iis:dispap:iiisdp062

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Keywords: credit rating; rating agency; sovereign debt; global game;

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Citations

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Cited by:
  1. Marco Di Maggio, 2007. "Information sharing in emerging credit markets," Economics Bulletin, AccessEcon, vol. 4(37), pages 1-7.
  2. Dion Bongaerts & K. J. Martijn Cremers & William N. Goetzmann, 2012. "Tiebreaker: Certification and Multiple Credit Ratings," Journal of Finance, American Finance Association, vol. 67(1), pages 113-152, 02.
  3. Sanne Zwart, 2005. "Liquidity runs with endogenous information acquisition," Economics Working Papers ECO2005/18, European University Institute.
  4. Christopher F. Baum & Margarita Karpava & Dorothea Schäfer & Andreas Stephan, 2013. "Credit Rating Agency Announcements and the Eurozone Sovereign Debt Crisis," Discussion Papers of DIW Berlin 1333, DIW Berlin, German Institute for Economic Research.
  5. Bussière, M. & Ristiniemi, A., 2012. "Credit Ratings and Debt Crises," Working papers 396, Banque de France.
  6. repec:ebl:ecbull:v:4:y:2007:i:37:p:1-7 is not listed on IDEAS
  7. Gärtner, Manfred & Griesbach, Björn, 2012. "Rating agencies, self-fulfilling prophecy and multiple equilibria? An empirical model of the European sovereign debt crisis 2009-2011," Economics Working Paper Series 1215, University of St. Gallen, School of Economics and Political Science.
  8. Christopher F. Baum & Margarita Karpava & Dorothea Schäfer & Andreas Stephan, 2013. "Credit Rating Agency Downgrades and the Eurozone Sovereign Debt Crises," Boston College Working Papers in Economics 841, Boston College Department of Economics, revised 30 Jan 2014.

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