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Rating Inflation versus Deflation: On Procyclical Credit Ratings

Author Info

  • 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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File URL: https://mpra.ub.uni-muenchen.de/51159/1/MPRA_paper_51159.pdf
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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;

Find related papers by JEL classification:

  • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
  • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
  • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage

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  1. Mariano, Beatriz, 2012. "Market power and reputational concerns in the ratings industry," Journal of Banking & Finance, Elsevier, vol. 36(6), pages 1616-1626.
  2. Patrick Bolton & Xavier Freixas & Joel Shapiro, 2010. "The credit ratings game," Economics Working Papers 1221, Department of Economics and Business, Universitat Pompeu Fabra.
  3. 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.
  4. Antoine Faure-Grimaud & Eloïc Peyrache & Lucía Quesada, 2009. "The ownership of ratings," RAND Journal of Economics, RAND Corporation, vol. 40(2), pages 234-257.
  5. Doron Kliger & Oded Sarig, 2000. "The Information Value of Bond Ratings," Journal of Finance, American Finance Association, vol. 55(6), pages 2879-2902, December.
  6. Bar-Isaac, Heski & Shapiro, Joel, 2010. "Ratings Quality over the Business Cycle," CEPR Discussion Papers 8156, C.E.P.R. Discussion Papers.
  7. 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.
  8. G. Ferri & L.-G. Liu & J. E. Stiglitz, 1999. "The Procyclical Role of Rating Agencies: Evidence from the East Asian Crisis," Economic Notes, Banca Monte dei Paschi di Siena SpA, vol. 28(3), pages 335-355, November.
  9. Arnoud W. A. Boot & Todd T. Milbourn & Anjolein Schmeits, 2006. "Credit Ratings as Coordination Mechanisms," Review of Financial Studies, Society for Financial Studies, vol. 19(1), pages 81-118.
  10. 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.
  11. Vasiliki Skreta & Laura Veldkamp, 2009. "Ratings Shopping and Asset Complexity: A Theory of Ratings Inflation," NBER Working Papers 14761, National Bureau of Economic Research, Inc.
  12. 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.
  13. Adam B. Ashcraft & Paul Goldsmith-Pinkham & James Vickery, 2010. "MBS ratings and the mortgage credit boom," Staff Reports 449, Federal Reserve Bank of New York.
  14. 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.
  15. Lawrence J. White, 2010. "Markets: The Credit Rating Agencies," Journal of Economic Perspectives, American Economic Association, vol. 24(2), pages 211-26, Spring.
  16. repec:fth:pennfi:67 is not listed on IDEAS
  17. Becker, Bo & Milbourn, Todd, 2011. "How did increased competition affect credit ratings?," Journal of Financial Economics, Elsevier, vol. 101(3), pages 493-514, September.
  18. Amato, Jeffery D. & Furfine, Craig H., 2004. "Are credit ratings procyclical?," Journal of Banking & Finance, Elsevier, vol. 28(11), pages 2641-2677, November.
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