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Feedback Effects of Credit Ratings

  • Gustavo Manso

    (MIT)

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    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) a rating agency should focus not only on the accuracy of its ratings but also on the effects of its ratings on the probability of survival of the borrower; (ii) even when a rating agency pursues 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.

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    File URL: https://economicdynamics.org/meetpapers/2011/paper_1338.pdf
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    Paper provided by Society for Economic Dynamics in its series 2011 Meeting Papers with number 1338.

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    Date of creation: 2011
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    Handle: RePEc:red:sed011:1338
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    Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

    Web page: http://www.EconomicDynamics.org/
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