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Rating Inflation versus Deflation: On Procyclical Credit Ratings

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  • Chen, Yongmin
  • Gu, Dingwei
  • Yao, Zhiyong

Abstract

Credit rating agencies play a crucial role in financial markets. There are two competing views regarding their behavior: some argue that they engage in rating inflation, while others suggest that they deflate ratings. This article offers a rationale that reconciles the two opposite arguments. We find that both rating inflation and rating deflation can occur in equilibrium. Furthermore, we show that credit rating is procyclical: rating inflation is more likely to happen in a boom while rating deflation is more likely to happen in a recession.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 51159.

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Date of creation: 02 Nov 2013
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Handle: RePEc:pra:mprapa:51159

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Keywords: rating inflation; rating deflation; procyclical rating;

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  1. Arnoud W. A. Boot & Todd T. Milbourn, 2002. "Credit Ratings as Coordination Mechanisms," William Davidson Institute Working Papers Series 457, William Davidson Institute at the University of Michigan.
  2. Adam Ashcraft & Paul Goldsmith-Pinkham & James Vickery, 2010. "MBS ratings and the mortgage credit boom," Staff Reports 449, Federal Reserve Bank of New York.
  3. Patrick Bolton & Xavier Freixas & Joel Shapiro, 2010. "The Credit Ratings Game," Working Papers 468, Barcelona Graduate School of Economics.
  4. Mariano, Beatriz, 2012. "Market power and reputational concerns in the ratings industry," Journal of Banking & Finance, Elsevier, vol. 36(6), pages 1616-1626.
  5. Bar-Isaac, Heski & Shapiro, Joel, 2010. "Ratings Quality over the Business Cycle," CEPR Discussion Papers 8156, C.E.P.R. Discussion Papers.
  6. Vasiliki Skreta & Laura Veldkamp, 2008. "Ratings Shopping and Asset Complexity: A Theory of Ratings Inflation," Working Papers 08-28, New York University, Leonard N. Stern School of Business, Department of Economics.
  7. Amato, Jeffery D. & Furfine, Craig H., 2004. "Are credit ratings procyclical?," Journal of Banking & Finance, Elsevier, vol. 28(11), pages 2641-2677, November.
  8. Becker, Bo & Milbourn, Todd, 2011. "How did increased competition affect credit ratings?," Journal of Financial Economics, Elsevier, vol. 101(3), pages 493-514, September.
  9. Marshall E. Blume & Felix Lim & A. Craig MacKinlay, . "The Declining Credit Quality of US Corporate Debt: Myth or Reality?," Rodney L. White Center for Financial Research Working Papers 03-98, Wharton School Rodney L. White Center for Financial Research.
  10. Marshall E. Blume & Felix Lim & A. Craig Mackinlay, 1998. "The Declining Credit Quality of U.S. Corporate Debt: Myth or Reality?," Journal of Finance, American Finance Association, vol. 53(4), pages 1389-1413, 08.
  11. Lawrence J. White, 2010. "Markets: The Credit Rating Agencies," Journal of Economic Perspectives, American Economic Association, vol. 24(2), pages 211-26, Spring.
  12. repec:fth:pennfi:67 is not listed on IDEAS
  13. Doron Kliger & Oded Sarig, . "The Information Value of Bond Ratings," Rodney L. White Center for Financial Research Working Papers 13-97, Wharton School Rodney L. White Center for Financial Research.
  14. Faure-Grimaud, Antoine & Peyrache, Eloïc & Quesada, Lucía, 2005. "The Ownership of Ratings," CEPR Discussion Papers 5432, C.E.P.R. Discussion Papers.
  15. Heski Bar-Isaac & Joel Shapiro, 2011. "Credit Ratings Accuracy and Analyst Incentives," American Economic Review, American Economic Association, vol. 101(3), pages 120-24, May.
  16. Mathis, Jérôme & McAndrews, James & Rochet, Jean-Charles, 2009. "Rating the raters: Are reputation concerns powerful enough to discipline rating agencies?," Journal of Monetary Economics, Elsevier, vol. 56(5), pages 657-674, July.
  17. Marshall E. Blume & Felix Lim & A. Craig MacKinlay, . "The Declining Credit Quality of US Corporate Debt: Myth or Reality?," Rodney L. White Center for Financial Research Working Papers 3-98, Wharton School Rodney L. White Center for Financial Research.
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