Feedback effects of credit ratings

Gustavo Manso

Journal of Financial Economics, 2013, vol. 109, issue 2, 535-548

Abstract: 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) rating agencies should focus not only on the accuracy of their ratings but also on the effects of their ratings on the probability of survival of the borrower; (ii) even when rating agencies pursue 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.

Keywords: Credit rating agencies; Performance-sensitive debt; Financial regulation; Credit-cliff dynamic (search for similar items in EconPapers)
JEL-codes: G01 G24 G32 (search for similar items in EconPapers)
Date: 2013
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Citations: View citations in EconPapers (76)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:109:y:2013:i:2:p:535-548

DOI: 10.1016/j.jfineco.2013.03.007

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