Ratings Shopping and Asset Complexity: A Theory of Ratings Inflation

Vasiliki Skreta and Laura Veldkamp

No 14761, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Many identify inflated credit ratings as one contributor to the recent financial market turmoil. We develop an equilibrium model of the market for ratings and use it to examine possible origins of and cures for ratings inflation. In the model, asset issuers can shop for ratings -- observe multiple ratings and disclose only the most favorable -- before auctioning their assets. When assets are simple, agencies' ratings are similar and the incentive to ratings shop is low. When assets are sufficiently complex, ratings differ enough that an incentive to shop emerges. Thus, an increase in the complexity of recently-issued securities could create a systematic bias in disclosed ratings, despite the fact that each ratings agency produces an unbiased estimate of the asset's true quality. Increasing competition among agencies would only worsen this problem. Switching to an investor-initiated ratings system alleviates the bias, but could collapse the market for information.

JEL-codes: D02 D53 D8 G01 G24 (search for similar items in EconPapers)
Date: 2009-02
Note: AP CF ME
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (235)

Published as Skreta, Vasiliki & Veldkamp, Laura, 2009. "Ratings shopping and asset complexity: A theory of ratings inflation," Journal of Monetary Economics, Elsevier, vol. 56(5), pages 678-695, July.

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Journal Article: Ratings shopping and asset complexity: A theory of ratings inflation (2009)
Working Paper: Ratings Shopping and Asset Complexity: A Theory of Ratings Inflation (2008)
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