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Competition, communication and rating bias

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  • Farkas, Miklós

Abstract

I compare the efficiency of different equilibria reached in a credit rating game that allows for communication between the issuer and two credit rating agencies (CRAs) prior to disclosing ratings. CRAs observe private signals that correlate with asset quality and can learn about each other’s signals by exchanging messages with the issuer. Conflicts of interest lead CRAs to provide biased ratings. When issuer messages are informative about signals, CRAs find it optimal to selectively offer biased ratings based on issuer messages. Messages are informative when the issuer discloses high ratings from both CRAs and profits more from increasing issuance than from selling its worst assets. The equilibrium in which only one CRA provides ratings leads to the highest efficiency when average asset quality is low, agency signals frequently disagree and asset payoffs are skewed.

Suggested Citation

  • Farkas, Miklós, 2021. "Competition, communication and rating bias," Journal of Economic Behavior & Organization, Elsevier, vol. 189(C), pages 637-656.
  • Handle: RePEc:eee:jeborg:v:189:y:2021:i:c:p:637-656
    DOI: 10.1016/j.jebo.2021.07.016
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    References listed on IDEAS

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    More about this item

    Keywords

    Credit rating agency; Communication; Securitization; Market structure;
    All these keywords.

    JEL classification:

    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection
    • D60 - Microeconomics - - Welfare Economics - - - General
    • C72 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Noncooperative Games
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage

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