Competition, communication and rating bias

I compare the efficiency of different equilibria reached in a credit rating game that allows for communication between the issuer and two credit rating agencies (CRAs) prior to disclosing ratings. CRAs observe private signals that correlate with asset quality and can learn about each other’s signals...

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Bibliographic Details
Published in:Journal of economic behavior & organization 2021-09, Vol.189, p.637-656
Main Author: Farkas, Miklós
Format: Article
Language:English
Subjects:
Communication
Credit rating agency
Market structure
Securitization
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Summary:I compare the efficiency of different equilibria reached in a credit rating game that allows for communication between the issuer and two credit rating agencies (CRAs) prior to disclosing ratings. CRAs observe private signals that correlate with asset quality and can learn about each other’s signals by exchanging messages with the issuer. Conflicts of interest lead CRAs to provide biased ratings. When issuer messages are informative about signals, CRAs find it optimal to selectively offer biased ratings based on issuer messages. Messages are informative when the issuer discloses high ratings from both CRAs and profits more from increasing issuance than from selling its worst assets. The equilibrium in which only one CRA provides ratings leads to the highest efficiency when average asset quality is low, agency signals frequently disagree and asset payoffs are skewed.
ISSN:0167-2681
1879-1751
DOI:10.1016/j.jebo.2021.07.016