Feedback effects between credit ratings and financial markets |
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| Affiliation: | 1. Faculdade de Economia, Universidade do Porto, Rua Dr. Roberto Frias, Porto, Portugal;2. Centre for Economics and Finance, Universidade do Porto, Portugal;1. Department of Economics, 364 FCBE, University of Memphis, Memphis, TN 38152, USA;2. Department of Economics, 432 FAB, University of Memphis, Memphis, TN 38152, USA;1. School of Business, East China University of Science and Technology, 130 Meilong Road, Shanghai 200237, China;2. Department of Finance, East China University of Science and Technology, Shanghai 200237, China;3. Department of Economics, University of Waterloo, 200 University Avenue West, Ontario, N2L 3G1, Canada;1. ESSCA School of Management, France;2. Institut Supérieur de Gestion, 2000, Le Bardo, University of Tunis, Tunisia;3. LAREQUAD FSEG de Tunis, University of Tunis El Manar, Tunisia;1. Department of Economics and Trade, Dalian Maritime University, 1 Linghai Road, Dalian 116026, China;2. Department of Economics, Chonnam National University, 77 Yongbong-Ro, Bukgu, Gwangju 61186, South Korea |
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| Abstract: | Credit rating agencies often make sharp adjustments in their pronouncements during times of stress in financial markets. These adjustments typically happen with a delay relative to shocks in market prices. Since prices convey information about what market participants are doing and thinking, it is likely that rating agencies take into account market prices when issuing their pronouncements.In order to understand the relationship between credit ratings and financial prices, we develop a model of debt roll-over in which rating agencies incorporate information publicly available in financial markets. We find that (1) rating agencies respond to market prices, i.e. nonfundamental price volatility can shift financing conditions from a low risk spread and high credit rating equilibrium to an equilibrium with high spread and low rating, and (2) rating agencies can anchor expectations about the equilibrium in financial markets, thus serving as an antidote to nonfundamental price volatility. |
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| Keywords: | Credit ratings Roll-over risk Creditor coordination D82 G18 G24 |
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