IDEAS home Printed from https://ideas.repec.org/a/eee/jbfina/v49y2014icp100-112.html
   My bibliography  Save this article

Credit rating dynamics and competition

Author

Listed:
  • Hirth, Stefan

Abstract

I analyze the market for credit ratings with competition between more than two rating agencies. How can honest rating behavior be achieved, and under which conditions can a new honest rating agency successfully invade a market with inflating incumbents? My model predicts cyclic dynamics if sophisticated investors have a high impact on agencies’ reputation. In contrast, if trusting investors have the main impact, then the dynamics exhibits a saddle point rather than cycles. In this case, regulatory support for honest rating agencies is only needed for a limited time, but the effect is sustainable in the long run.

Suggested Citation

  • Hirth, Stefan, 2014. "Credit rating dynamics and competition," Journal of Banking & Finance, Elsevier, vol. 49(C), pages 100-112.
    • Handle: RePEc:eee:jbfina:v:49:y:2014:i:c:p:100-112
    DOI: 10.1016/j.jbankfin.2014.08.011
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S0378426614002787
    Download Restriction: Full text for ScienceDirect subscribers only
    File URL: https://libkey.io/10.1016/j.jbankfin.2014.08.011?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Mathis, Jérôme & McAndrews, James & Rochet, Jean-Charles, 2009. "Rating the raters: Are reputation concerns powerful enough to discipline rating agencies?," Journal of Monetary Economics, Elsevier, vol. 56(5), pages 657-674, July.
    2. Jie He & Jun Qian & Philip E. Strahan, 2011. "Credit Ratings and the Evolution of the Mortgage-Backed Securities Market," American Economic Review, American Economic Association, vol. 101(3), pages 131-135, May.
    3. Milidonis, Andreas, 2013. "Compensation incentives of credit rating agencies and predictability of changes in bond ratings and financial strength ratings," Journal of Banking & Finance, Elsevier, vol. 37(9), pages 3716-3732.
    4. Jeon, Doh-Shin & Lovo, Stefano, 2011. "Reputation as an Entry Barrier in the Credit Rating Industry," TSE Working Papers 11-235, Toulouse School of Economics (TSE), revised 25 May 2012.
    5. Patrick Bolton & Xavier Freixas & Joel Shapiro, 2012. "The Credit Ratings Game," Journal of Finance, American Finance Association, vol. 67(1), pages 85-112, February.
    6. Bar-Isaac, Heski & Shapiro, Joel, 2013. "Ratings quality over the business cycle," Journal of Financial Economics, Elsevier, vol. 108(1), pages 62-78.
    7. Stahl, Konrad & Strausz, Roland, 2010. "Who Should Pay for Certification?," Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems 323, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
    8. Becker, Bo & Milbourn, Todd, 2011. "How did increased competition affect credit ratings?," Journal of Financial Economics, Elsevier, vol. 101(3), pages 493-514, September.
    9. Doherty, Neil A. & Kartasheva, Anastasia V. & Phillips, Richard D., 2012. "Information effect of entry into credit ratings market: The case of insurers' ratings," Journal of Financial Economics, Elsevier, vol. 106(2), pages 308-330.
    10. Skreta, Vasiliki & Veldkamp, Laura, 2009. "Ratings shopping and asset complexity: A theory of ratings inflation," Journal of Monetary Economics, Elsevier, vol. 56(5), pages 678-695, July.
    11. Dion Bongaerts & K. J. Martijn Cremers & William N. Goetzmann, 2012. "Tiebreaker: Certification and Multiple Credit Ratings," Journal of Finance, American Finance Association, vol. 67(1), pages 113-152, February.
    12. Marco Pagano & Paolo Volpin, 2010. "Credit ratings failures and policy options [Cash-in-the-market pricing and optimal resolution of bank failures]," Economic Policy, CEPR, CESifo, Sciences Po;CES;MSH, vol. 25(62), pages 401-431.
    13. Friedman, Daniel, 1991. "Evolutionary Games in Economics," Econometrica, Econometric Society, vol. 59(3), pages 637-666, May.
    14. Jorgen W. Weibull, 1997. "Evolutionary Game Theory," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262731215, April.
    15. Manso, Gustavo, 2013. "Feedback effects of credit ratings," Journal of Financial Economics, Elsevier, vol. 109(2), pages 535-548.
    16. Mariano, Beatriz, 2012. "Market power and reputational concerns in the ratings industry," Journal of Banking & Finance, Elsevier, vol. 36(6), pages 1616-1626.
    17. Jie (Jack) He & Jun (Qj) Qian & Philip E. Strahan, 2012. "Are All Ratings Created Equal? The Impact of Issuer Size on the Pricing of Mortgage-Backed Securities," Journal of Finance, American Finance Association, vol. 67(6), pages 2097-2137, December.
    18. repec:hhs:iuiwop:487 is not listed on IDEAS
    19. Stolper, Anno, 2009. "Regulation of credit rating agencies," Journal of Banking & Finance, Elsevier, vol. 33(7), pages 1266-1273, July.
    20. Opp, Christian C. & Opp, Marcus M. & Harris, Milton, 2013. "Rating agencies in the face of regulation," Journal of Financial Economics, Elsevier, vol. 108(1), pages 46-61.
    21. Paolo Fulghieri & Günter Strobl & Han Xia, 2014. "The Economics of Solicited and Unsolicited Credit Ratings," The Review of Financial Studies, Society for Financial Studies, vol. 27(2), pages 484-518.
    22. Cantor, Richard & Packer, Frank, 1997. "Differences of opinion and selection bias in the credit rating industry," Journal of Banking & Finance, Elsevier, vol. 21(10), pages 1395-1417, October.
    23. Ramin P. Baghai & Henri Servaes & Ane Tamayo, 2014. "Have Rating Agencies Become More Conservative? Implications for Capital Structure and Debt Pricing," Journal of Finance, American Finance Association, vol. 69(5), pages 1961-2005, October.
    24. Klein, Benjamin & Leffler, Keith B, 1981. "The Role of Market Forces in Assuring Contractual Performance," Journal of Political Economy, University of Chicago Press, vol. 89(4), pages 615-641, August.
    25. Xia, Han, 2014. "Can investor-paid credit rating agencies improve the information quality of issuer-paid rating agencies?," Journal of Financial Economics, Elsevier, vol. 111(2), pages 450-468.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Marta Allegra Ronchetti, 2018. "What if I knew you did it? An analysis of preliminary ratings’ disclosure under competition," Discussion Papers 2018/09, University of Nottingham, Centre for Finance, Credit and Macroeconomics (CFCM).
    2. Christian Siemering, 2021. "The economics of dishonest insurance companies," The Geneva Risk and Insurance Review, Palgrave Macmillan;International Association for the Study of Insurance Economics (The Geneva Association), vol. 46(1), pages 1-20, March.
    3. Nelson Camanho & Pragyan Deb & Zijun Liu, 2022. "Credit rating and competition," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 27(3), pages 2873-2897, July.
    4. Xiangyun Zhou & Yixiang Tian & Ping Zhang & Xiurong Chen, 2018. "Incentive and constraint regulations of rating inflation in collusion over the separation of economic cycles - Markov rating shopping dual reputation model," PLOS ONE, Public Library of Science, vol. 13(10), pages 1-18, October.
    5. Patrycja Chodnicka-Jaworska, 2016. "Credit Ratings Inflation Phenomenon – Are There Any Diffrences in the Credit Ratings Determinants? (Zjawisko inflacji credit ratingow – czy wystepuja roznice w determinantach credit ratingow?)," Research Reports, University of Warsaw, Faculty of Management, vol. 2(22), pages 48-59.
    6. Barth, Andreas & Laturnus, Valerie & Mansouri, Sasan & Wagner, Alexander, 2021. "ICO analysts," VfS Annual Conference 2021 (Virtual Conference): Climate Economics 242429, Verein für Socialpolitik / German Economic Association.
    7. Matthias Efing, 2012. "Bank Capital Regulation with an Opportunistic Rating Agency," Swiss Finance Institute Research Paper Series 12-19, Swiss Finance Institute.
    8. Jess N. Cornaggia & Kimberly J. Cornaggia & John E. Hund, 2017. "Credit Ratings Across Asset Classes: A Long-Term Perspective," Review of Finance, European Finance Association, vol. 21(2), pages 465-509.
    9. Michael R. King & Steven Ongena & Nikola Tarashev, 2020. "Bank Standalone Credit Ratings," International Journal of Central Banking, International Journal of Central Banking, vol. 16(4), pages 101-144, September.
    10. Pan, Qiuhui & Wang, Yue & He, Mingfeng, 2022. "Impacts of special cooperation strategy with reward and punishment mechanism on cooperation evolution," Chaos, Solitons & Fractals, Elsevier, vol. 162(C).
    11. Xiangyun Zhou, 2021. "Can the dual-rating regulation improve the rating quality of Chinese corporate bonds?," PLOS ONE, Public Library of Science, vol. 16(12), pages 1-15, December.
    12. Jean Paul Rabanal & Olga A Rud, 2018. "Does Competition Affect Truth Telling? An Experiment with Rating Agencies," Review of Finance, European Finance Association, vol. 22(4), pages 1581-1604.
    13. Jones, Laurence & Alsakka, Rasha & ap Gwilym, Owain & Mantovan, Noemi, 2022. "Regulating rating agencies: A conservative behavioural change," Journal of Financial Stability, Elsevier, vol. 60(C).
    14. Douglas Silveira & Izak Silva & Silvinha Vasconcelos & Fernando Perobelli, 2020. "The Brexit game: uncertainty and location decision," Papers in Regional Science, Wiley Blackwell, vol. 99(6), pages 1515-1538, December.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Nelson Camanho & Pragyan Deb & Zijun Liu, 2022. "Credit rating and competition," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 27(3), pages 2873-2897, July.
    2. Jeon, Doh-Shin & Lovo, Stefano, 2013. "Credit rating industry: A helicopter tour of stylized facts and recent theories," International Journal of Industrial Organization, Elsevier, vol. 31(5), pages 643-651.
    3. Xia, Han, 2014. "Can investor-paid credit rating agencies improve the information quality of issuer-paid rating agencies?," Journal of Financial Economics, Elsevier, vol. 111(2), pages 450-468.
    4. Sean Flynn & Andra Ghent, 2018. "Competition and Credit Ratings After the Fall," Management Science, INFORMS, vol. 64(4), pages 1672-1692, April.
    5. Farkas, Miklós, 2021. "Competition, communication and rating bias," Journal of Economic Behavior & Organization, Elsevier, vol. 189(C), pages 637-656.
    6. Cornaggia, Jess & Cornaggia, Kimberly J. & Xia, Han, 2016. "Revolving doors on Wall Street," Journal of Financial Economics, Elsevier, vol. 120(2), pages 400-419.
    7. Bae, Kee-Hong & Driss, Hamdi & Roberts, Gordon S., 2019. "Does competition affect ratings quality? Evidence from Canadian corporate bonds," Journal of Corporate Finance, Elsevier, vol. 58(C), pages 605-623.
    8. Valentina Bruno & Jess Cornaggia & Kimberly J. Cornaggia, 2016. "Does Regulatory Certification Affect the Information Content of Credit Ratings?," Management Science, INFORMS, vol. 62(6), pages 1578-1597, June.
    9. Attig, Najah & Driss, Hamdi & El Ghoul, Sadok, 2021. "Credit ratings quality in uncertain times," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 75(C).
    10. Lawrence J. White, 2013. "Credit Rating Agencies: An Overview," Annual Review of Financial Economics, Annual Reviews, vol. 5(1), pages 93-122, November.
    11. Wenming Xu & Yan Liu, 2021. "Does reputational capital affect credit rating agencies?: empirical evidence from a natural experiment in China," European Journal of Law and Economics, Springer, vol. 51(3), pages 433-468, June.
    12. Jess N. Cornaggia & Kimberly J. Cornaggia & John E. Hund, 2017. "Credit Ratings Across Asset Classes: A Long-Term Perspective," Review of Finance, European Finance Association, vol. 21(2), pages 465-509.
    13. Yun Wang & Yilan Xu, 2015. "Race to the Top: Credit Rating Bias from Competition," Working Papers 2015-05-12, Wang Yanan Institute for Studies in Economics (WISE), Xiamen University, revised 10 Jul 2015.
    14. Brendan Daley & Brett Green & Victoria Vanasco, 2020. "Securitization, Ratings, and Credit Supply," Journal of Finance, American Finance Association, vol. 75(2), pages 1037-1082, April.
    15. Liu, Yan, 2023. "Essays on credit rating agencies in China," Other publications TiSEM b54b3315-1185-48b8-aaf8-8, Tilburg University, School of Economics and Management.
    16. Marta Allegra Ronchetti, 2018. "What if I knew you did it? An analysis of preliminary ratings’ disclosure under competition," Discussion Papers 2018/09, University of Nottingham, Centre for Finance, Credit and Macroeconomics (CFCM).
    17. Vu, Huong & Alsakka, Rasha & ap Gwilym, Owain, 2022. "Does competition improve sovereign credit rating quality?," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 76(C).
    18. Ozerturk, Saltuk, 2014. "Ratings as regulatory stamps," Journal of Economic Behavior & Organization, Elsevier, vol. 105(C), pages 17-29.
    19. Gerald J. Lobo & Luc Paugam & Hervé Stolowy & Pierre Astolfi, 2017. "The Effect of Business and Financial Market Cycles on Credit Ratings: Evidence from the Last Two Decades," Abacus, Accounting Foundation, University of Sydney, vol. 53(1), pages 59-93, March.
    20. Efing, Matthias & Hau, Harald, 2015. "Structured debt ratings: Evidence on conflicts of interest," Journal of Financial Economics, Elsevier, vol. 116(1), pages 46-60.

    More about this item

    Keywords

    Credit rating agencies; Ratings inflation; Evolutionary game theory;
    All these keywords.

    JEL classification:

    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • L15 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Information and Product Quality

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:jbfina:v:49:y:2014:i:c:p:100-112. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/jbf .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.