Risk, ambiguity and sovereign rating

Di Caro, Paolo (2014): Risk, ambiguity and sovereign rating. Published in: International Economics and Economic Policy No. online first (6 June 2014)

Abstract

Decisions of investing in sovereign assets involve both risk and ambiguity. Ambiguity arises from unknown elements characterizing the value of a generic sovereign. In presence of ambiguity, ambiguity-averse investors are prone to pay for obtaining summary information such as ratings which reduces ambiguity. Ambiguity-neutral and ambiguity-averse investors, then, make decisions on the basis of different informative sources. By presenting a simple model of sovereign rating under ambiguity, three facts occurring in today’s financial markets are explained. Sovereign ratings influence decisions of investment of ambiguity-sensitive individuals. Rating-dependent regulations create distortions in financial markets by institutionalising specific summary signals. Providing ratings may be a profitable activity. Some final suggestions propose future areas of theoretical and empirical research.

• Item Type: MPRA Paper
• Language: English
• Keywords: risk, ambiguity, ambiguity aversion, sovereign rating, value of information
• Subjects: D - Microeconomics > D8 - Information, Knowledge, and Uncertainty; D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D81 - Criteria for Decision-Making under Risk and Uncertainty; G - Financial Economics > G1 - General Financial Markets

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