Quotation Elendner, Hermann. 2012. Rating-Induced Default Risk and Downgrade Hesitation. Financial Management Association European Conference, Istanbul, Türkei, 06.06.-08.06..




Credit ratings should reflect credit risk. Mounting evidence implies they also impact credit risk. As strategic agencies will take this into account, I build a model to show how this feedback effect incentivizes raters to postpone or omit downgrades which they know would be warranted. If agencies succumb to the conflict of interest, they restrict self-inflicted fee losses by optimally hesitating to announce a strictly positive fraction of merited announcements. In equilibrium, ratings are informative, but only partially, because the agency withholds information---irrespective of any level of reputation costs. The model is rich in empirical predictions: It is shown that the probability of agencies concealing downgrades is increasing with obligors' proximity to default and their reliance on external financing, while decreasing in distance to the default boundary and subsequent to crises due to higher reputation costs. For opaque firms more information is held back. Finally, I derive an identification strategy for empirical tests of the predictions based on CDS spreads and market-implied ratings.


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Publication's profile

Status of publication Published
Affiliation WU
Type of publication Paper presented at an academic conference or symposium
Language English
Title Rating-Induced Default Risk and Downgrade Hesitation
Event Financial Management Association European Conference
Year 2012
Date 06.06.-08.06.
Country Turkey
Location Istanbul
URL http://fma.org/Istanbul


Elendner, Hermann (Former researcher)
Institute for Financial Research IN (Details)
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