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Alternatives for issuer-paid credit rating agencies

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  • Bongaerts, Dion

Abstract

This paper investigates the economic viability and welfare contribution of alternatives to issuer-paid credit rating agencies (CRAs). To this end, it introduces a heterogeneous competition model for credit and ratings markets. Frictions among issuers or investors induce rating inflation from issuer-paid CRAs. Investor-paid CRAs suffer from three sources of free-riding and are generally not economically viable when competing with issuer-paid CRAs. Only for very limited parameter ranges can investor-paid CRAs thrive and counter rating inflation. Other proposed alternatives such as investor-produced ratings and CRA co-investments employ skin-in-the-game to induce proper screening accuracy. However, as traditional issuer-paid CRAs can cater better to issuers, such alternatives generate little demand or are implemented ineffectively. Hence, this paper provides an explanation for the evolution, dominance and resiliency of issuer-paid CRAs. JEL Classification: G24, G28, L14

Suggested Citation

  • Bongaerts, Dion, 2014. "Alternatives for issuer-paid credit rating agencies," Working Paper Series 1703, European Central Bank.
  • Handle: RePEc:ecb:ecbwps:20141703
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    File URL: https://www.ecb.europa.eu//pub/pdf/scpwps/ecbwp1703.pdf
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    References listed on IDEAS

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    1. Anil K. Kashyap & Natalia Kovrijnykh, 2016. "Who Should Pay for Credit Ratings and How?," Review of Financial Studies, Society for Financial Studies, vol. 29(2), pages 420-456.
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    Cited by:

    1. Keser, Claudia & Özgümüs, Asri & Peterlé, Emmanuel & Schmidt, Martin, 2017. "An experimental investigation of rating-market regulation," Journal of Economic Behavior & Organization, Elsevier, vol. 144(C), pages 78-86.
    2. repec:sgm:resrep:v:2:i:22:y:2016:p:48-59 is not listed on IDEAS

    More about this item

    Keywords

    competition; credit rating agencies; regulation; reputation;

    JEL classification:

    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation

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