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Feedback effects of credit ratings

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  • Manso, Gustavo

Abstract

Rating agencies are often criticized for being biased in favor of borrowers, for being too slow to downgrade following credit quality deterioration, and for being oligopolists. Based on a model that takes into account the feedback effects of credit ratings, I show that: (i) rating agencies should focus not only on the accuracy of their ratings but also on the effects of their ratings on the probability of survival of the borrower; (ii) even when rating agencies pursue an accurate rating policy, multi-notch downgrades or immediate default may occur in response to small shocks to fundamentals; (iii) increased competition between rating agencies can lead to rating downgrades, increasing default frequency and reducing welfare.

Suggested Citation

  • Manso, Gustavo, 2013. "Feedback effects of credit ratings," Journal of Financial Economics, Elsevier, vol. 109(2), pages 535-548.
    • Handle: RePEc:eee:jfinec:v:109:y:2013:i:2:p:535-548
    DOI: 10.1016/j.jfineco.2013.03.007
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    More about this item

    Keywords

    Credit rating agencies; Performance-sensitive debt; Financial regulation; Credit-cliff dynamic;
    All these keywords.

    JEL classification:

    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G01 - Financial Economics - - General - - - Financial Crises
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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