Repeated interaction and rating inflation: A model of double reputation

Research output: Contribution to journalArticlepeer-review

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.

Original languageEnglish
Pages (from-to)250-280
Number of pages31
JournalAmerican Economic Journal: Microeconomics
Volume7
Issue number1
DOIs
StatePublished - 2015
Externally publishedYes

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