Rating deflation versus inflation: On procyclical credit ratings

Zhiyong Yao (), Dingwei Gu and Yongmin Chen

Pacific-Basin Finance Journal, 2017, vol. 41, issue C, 46-64

Abstract: This article provides a theoretical analysis to reconcile the controversy between rating deflation versus inflation. In our model, the credit rating agency trades off between the current incomes paid by the issuer upon receiving a favorable rating and the future reputation costs. We show that both rating deflation and rating inflation can occur in equilibrium. Furthermore, credit ratings are procyclical since the probability of default is higher and thus the reputation costs are higher during recessions than during booms.

Keywords: Credit rating agencies; Rating deflation; Rating inflation; Business cycles (search for similar items in EconPapers)
JEL-codes: C73 D82 G24 L15 (search for similar items in EconPapers)
Date: 2017
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Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:pacfin:v:41:y:2017:i:c:p:46-64

DOI: 10.1016/j.pacfin.2016.12.003

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