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Journal of Finance Vol. 67 No. 1 2012

The Credit Ratings Game

Patrick Bolton1,2,3,4; Xavier Freixas5,3,6,7; Joel Shapiro5,8

1 National Bureau of Economic Research · 2 European Corporate Governance Institute · 3 Centre for Economic Policy Research · 4 Columbia University · 5 Universitat Pompeu Fabra · 6 Barcelona School of Economics · 7 Escola Brasileira de Economia e Finanças · 8 University of Oxford

open access

Abstract

The collapse of AAA‐rated structured finance products in 2007 to 2008 has brought renewed attention to conflicts of interest in credit rating agencies (CRAs). We model competition among CRAs with three sources of conflicts: (1) CRAs conflict of understating risk to attract business, (2) issuers' ability to purchase only the most favorable ratings, and (3) the trusting nature of some investor clienteles. These conflicts create two distortions. First, competition can reduce efficiency, as it facilitates ratings shopping. Second, ratings are more likely to be inflated during booms and when investors are more trusting. We also discuss efficiency‐enhancing regulatory interventions.

DOI
10.1111/j.1540-6261.2011.01708.x
Volume
67
Issue
1
Pages
85-111
Language
en
Sources
bibtex:phds-export.bib openalex crossref

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