Courage to Capital? A Model of the Effects of Rating Agencies on Sovereign Debt Roll–over

Galina Hale

The Institute for International Integration Studies Discussion Paper Series from IIIS

Abstract: With the rise of international bond markets in the 1990s, the role of sovereign credit ratings has become increasingly important. In the aftermath of Asian Crises a series of empirical studies on the effects of sovereign ratings appeared. The theoretical literature on the topic, however, remains rather scarce. We propose a model of rating agencies that is an application of global game theory in which heterogeneous investors act strategically. The model is consistent with the main findings of the empirical literature. In particular, it is able to explain the independent effect of sovereign ratings on the cost of debt. Our model also predicts that, in addition to affecting the level of debt roll–over, the mere existence of the rating agency's announcement can increase the magnitude of the response of capital flows to changes in fundamentals. In addition, introducing a rating agency to a market that otherwise would have the unique equilibrium can bring multiple equilibria. The model also allows us to explore the reasons why agencies may over–react to crises, how they can spread financial contagion, and the failure of rating agencies to predict crises. Classification-F34, G14, G15

Keywords: credit rating; rating agency; sovereign debt; global game (search for similar items in EconPapers)
Date: 2005-04-20
New Economics Papers: this item is included in nep-fin and nep-fmk
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Working Paper: Courage to Capital? A Model of the Effects of Rating Agencies on Sovereign Debt Role-over (2005)
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Persistent link: https://EconPapers.repec.org/RePEc:iis:dispap:iiisdp062

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