Munich Personal RePEc Archive

Rating Inflation versus Deflation: On Procyclical Credit Ratings

Chen, Yongmin and Gu, Dingwei and Yao, Zhiyong (2013): Rating Inflation versus Deflation: On Procyclical Credit Ratings.

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Abstract

Credit rating agencies play a crucial role in financial markets. There are two competing views regarding their behavior: some argue that they engage in rating inflation, while others suggest that they deflate ratings. This article offers a rationale that reconciles the two opposite arguments. We find that both rating inflation and rating deflation can occur in equilibrium. Furthermore, we show that credit rating is procyclical: rating inflation is more likely to happen in a boom while rating deflation is more likely to happen in a recession.

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