Efficiency of Competitive Rating Agencies

Abstract

This paper develops a model of rating migration by the credit rating agencies. We analyse how the rating agencies enhance efficiency. In this framework, we also investigate the possibility of a regulator increasing net surplus by appropriate policies. The firms have private information regarding the default probability of their projects. The investor is rational and has Bayesian beliefs. The rating agency is a profit maximizing intermediary. Effectiveness of some of the regulatory policies are highlighted.