DP11961 Credit Ratings and Market Information

Author(s): Alessio Piccolo, Joel Shapiro
Publication Date: April 2017
Keyword(s): Credit ratings
JEL(s): G24, G28
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=11961

How does market information affect credit ratings? How do credit ratings affect market information? We analyze a model in which a credit rating agency's (CRA's) rating is followed by a market for credit risk that provides a public signal - the price. A more accurate rating decreases market informativeness, as it diminishes mispricing and, hence, incentives for investor information acquisition. On the other hand, more-informative trading increases CRA accuracy incentives by making rating inflation more transparent. If the first effect is strong, policies that increase reputational sanctions on CRAs decrease rating inflation, but also decrease the total amount of information.