Up Next

ki-logo-white
Market-Based Solutions to Vital Economic Issues

SEARCH

ki-logo-white
Market-Based Solutions to Vital Economic Issues
Research
Oct 31, 2013

The Economics of Solicited and Unsolicited Credit Ratings

Abstract

This paper develops a dynamic rational expectations model of the credit rating process, incorporating three critical elements of this industry: (i) the rating agencies’ ability to misreport the issuer’s credit quality, (ii) their ability to issue unsolicited ratings, and (iii) their reputational concerns. We analyze the incentives of credit rating agencies to issue unsolicited credit ratings and the effects of this practice on the agencies’ rating strategies. We find that the issuance of unfavorable unsolicited credit ratings enables rating agencies to extract higher fees from issuers by credibly threatening to punish those that refuse to acquire a rating. Also, issuing unfavorable unsolicited ratings increases the rating agencies’ reputation by demonstrating to investors that they resist the temptation to issue inflated ratings. In equilibrium, unsolicited credit ratings are lower than solicited ratings, because all favorable ratings are solicited; however, they do not have a downward bias. We show that, under certain conditions, a credit rating system that incorporates unsolicited ratings leads to more stringent rating standards.

Note: Research papers posted on SSRN, including any findings, may differ from the final version chosen for publication in academic journals.


View Working Paper View Publication on UNC Library View Publication on Journal Site

You may also be interested in: