TY - JOUR
T1 - Information reliability and welfare
T2 - A theory of coarse credit ratings
AU - Goel, Anand M.
AU - Thakor, Anjan V.
N1 - Publisher Copyright:
© 2015.
PY - 2015/3/1
Y1 - 2015/3/1
N2 - An enduring puzzle is why credit rating agencies (CRAs) use a few categories to describe credit qualities lying in a continuum, even when ratings coarseness reduces welfare. We model a cheap-talk game in which a CRA assigns positive weights to the divergent goals of issuing firms and investors. The CRA wishes to inflate ratings but prefers an unbiased rating to one whose inflation exceeds a threshold. Ratings coarseness arises in equilibrium to preclude excessive rating inflation. We show that competition among CRAs can increase ratings coarseness. We also examine the welfare implications of regulatory initiatives.
AB - An enduring puzzle is why credit rating agencies (CRAs) use a few categories to describe credit qualities lying in a continuum, even when ratings coarseness reduces welfare. We model a cheap-talk game in which a CRA assigns positive weights to the divergent goals of issuing firms and investors. The CRA wishes to inflate ratings but prefers an unbiased rating to one whose inflation exceeds a threshold. Ratings coarseness arises in equilibrium to preclude excessive rating inflation. We show that competition among CRAs can increase ratings coarseness. We also examine the welfare implications of regulatory initiatives.
KW - Cheap talk
KW - Coarseness
KW - Credit quality
KW - Credit ratings
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U2 - 10.1016/j.jfineco.2014.11.005
DO - 10.1016/j.jfineco.2014.11.005
M3 - Article
AN - SCOPUS:84924576491
SN - 0304-405X
VL - 115
SP - 541
EP - 557
JO - Journal of Financial Economics
JF - Journal of Financial Economics
IS - 3
ER -