Credit Ratings and Investments

Anna Bayona, Oana Peia and Razvan Vlahu

Working Papers from DNB

Abstract: We study how inflated credit ratings affect investment decisions in bond markets using experimental coordination games. Theoretical models that feature a feedback effect between capital markets and the real economy suggest that inflated ratings can have both positive and negative real effects. We compare markets with and without a credit rating agency and find that ratings significantly impact investor behaviour and capital allocation to firms. We show that the main mechanism through which these real effects materialize is a shift in investors’ beliefs about the behaviour of other investors rather than firms’ underlying fundamentals. Our experimental results sug- gest that the positive impact of inflated ratings is likely to dominate in the presence of feedback effects since ratings act as a strong coordination mechanism resulting in enhanced market outcomes.

Keywords: Credit ratings; Imperfect information; Investor beliefs; Firm financing (search for similar items in EconPapers)
JEL-codes: D81 D82 D83 G24 (search for similar items in EconPapers)
Date: 2023-05
New Economics Papers: this item is included in nep-exp, nep-fdg and nep-fmk
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Persistent link: https://EconPapers.repec.org/RePEc:dnb:dnbwpp:776

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