Title Can Information Imprecision Be Valuable? The Case Of Credit Ratings

Keywords: Credit ratings, Coarseness, Information precision, Adverse selection, Effort moral hazard

Abstract:

We develop a model in which credit ratings are coarse relative to the underlying default probabilities and ratings precision is countercyclical. Ratings coarseness arises from the revenue-maximizing behavior of rating agencies, and it may maximize welfare even when greater precision can be costlessly achieved. The private outcome may differ from the socially desirable outcome – a social planner can improve welfare by putting a ceiling (floor) on the fee if the desired outcome is coarseness (precision). Strikingly, when information production is costless, the socially-optimal outcome is coarseness, but it does not arise in the laissez-faire equilibrium, thus necessitating regulatory intervention.

Bio:

https://www.york.ac.uk/economics/people/konstantinos-koufopoulos/