Credit Ratings and Market Information

Accurate credit ratings are important for both investors and regulators. We demonstrate that the market for credit risk provides an important source of discipline for credit rating agencies (CRAs). We examine a model in which a CRA’s rating is followed by a market for credit risk that provides a pub...

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Bibliographic Details
Published in:The Review of financial studies 2022-10, Vol.35 (10), p.4425-4473
Main Authors: Piccolo, Alessio, Shapiro, Joel
Format: Article
Language:English
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Summary:Accurate credit ratings are important for both investors and regulators. We demonstrate that the market for credit risk provides an important source of discipline for credit rating agencies (CRAs). We examine a model in which a CRA’s rating is followed by a market for credit risk that provides a public signal – the price. More informative trading increases the CRA’s incentives to be accurate by making rating errors more transparent. We show that this source of discipline is (a) robust to moral hazard, multiple CRAs, and connected primary and secondary markets and (b) specific to the market for credit risk.
ISSN:0893-9454
1465-7368
DOI:10.1093/rfs/hhac005