Repeated Interaction and Rating Inflation: A Model of Double Reputation
American Economic Journal: Microeconomics
vol. 7,
no. 1, February 2015
(pp. 250-80)
Abstract
Credit rating agencies have an incentive to maintain a public reputation for credibility among investors but also have an incentive to develop a second, private reputation for leniency among issuers. We show that in markets with few issuers, such as markets for structured assets, these incentives may lead rating agencies to inflate ratings as a strategic tool to form a "double reputation". The model extends the existing literature on "cheap-talk" reputation to the case of two audiences. Our results can explain why rating inflation occurred specifically in markets for MBSs and CDOs during the recent financial crisis. Policy implications are discussed. (JEL D82, G01, G12, G24, G32)Citation
Frenkel, Sivan. 2015. "Repeated Interaction and Rating Inflation: A Model of Double Reputation." American Economic Journal: Microeconomics, 7 (1): 250-80. DOI: 10.1257/mic.20110077Additional Materials
JEL Classification
- D82 Asymmetric and Private Information; Mechanism Design
- G01 Financial Crises
- G12 Asset Pricing; Trading Volume; Bond Interest Rates
- G24 Investment Banking; Venture Capital; Brokerage; Ratings and Ratings Agencies
- G32 Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
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