Information reliability and welfare: A theory of coarse credit ratings

Anand M. Goel; Anjan V. Thakor

doi:10.1016/j.jfineco.2014.11.005

Information reliability and welfare: A theory of coarse credit ratings

Anand M. Goel
, Anjan V. Thakor

Research output: Contribution to journal › Article › peer-review

48 Scopus citations

Abstract

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.

Original language	English
Pages (from-to)	541-557
Number of pages	17
Journal	Journal of Financial Economics
Volume	115
Issue number	3
DOIs	https://doi.org/10.1016/j.jfineco.2014.11.005
State	Published - Mar 1 2015

Keywords

Cheap talk
Coarseness
Credit quality
Credit ratings

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10.1016/j.jfineco.2014.11.005

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KW - Credit ratings

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ER -

Information reliability and welfare: A theory of coarse credit ratings

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Keywords

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