Information reliability and welfare: A theory of coarse credit ratings

Anand Goel (goelanand@gmail.com) and Anjan Thakor (thakor@wustl.edu)

Journal of Financial Economics, 2015, vol. 115, issue 3, 541-557

Abstract: An enduring puzzle is why credit rating agencies (CRAs) use a few categories to describe credit qualities lying in a continuum, even when ratings coarseness reduces welfare. We model a cheap-talk game in which a CRA assigns positive weights to the divergent goals of issuing firms and investors. The CRA wishes to inflate ratings but prefers an unbiased rating to one whose inflation exceeds a threshold. Ratings coarseness arises in equilibrium to preclude excessive rating inflation. We show that competition among CRAs can increase ratings coarseness. We also examine the welfare implications of regulatory initiatives.

Keywords: Credit ratings; Coarseness; Cheap talk; Credit quality (search for similar items in EconPapers)
JEL-codes: D82 D83 G24 G28 G31 G32 (search for similar items in EconPapers)
Date: 2015
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (37)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:115:y:2015:i:3:p:541-557

DOI: 10.1016/j.jfineco.2014.11.005

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