Procyclical Ratings Inflation and Limited Attention

초록

The massive collapse of high-rated assets during the 2007–2008 financial crisis has made investors attentive toward the intention of credit rating agencies. We incorporate this feature into our model of ratings inflation. We introduce limitedly attentive investors who are inattentive in normal times, but become attentive when high-rated assets default. The presence of limitedly attentive investors creates a friction in the updating process of credit rating agencies’ reputation. Consequently, we show that credit rating agencies are more likely to engage in ratings inflation as the number of limitedly attentive investors increases, leading to procyclical ratings inflation.

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