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Department of Economics, University of Oslo Memorandum

No 01/2013:
An Equilibrium Model of Credit Rating Agencies

Steinar Holden (), Gisle James Natvig () and Adrien Vigier ()

Abstract: We develop a model of credit rating agencies (CRAs) based on reputation concerns. Ratings a ect investors' choice and, thereby, also issuers' access to funding and default risk. We show that in equilibrium { the informational content of credit ratings is inferior to that of CRAs' private information. We nd that CRAs have a pro-cyclical impact on default risk: in a liq- uidity boom CRAs help resolve investors' coordination problem, and lower the probability of default; in a liquidity crunch CRAs raise the probability of default. Furthermore, rating stan- dards tend to be pro-cyclical, while biased CRA-incentives will ultimately be self-defeating.

Keywords: Credit rating agencies; global games; coordination failure; (follow links to similar papers)

JEL-Codes: C72; D82; G24; G33; (follow links to similar papers)

34 pages, December 18, 2012

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