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T-Space at The University of Toronto Libraries >
Theoretical Economics >
Volume 3, Number 3 (September 2008) >

Please use this identifier to cite or link to this item: http://hdl.handle.net/1807/16626

Title: Credible ratings
Authors: Ettore Damiano; Department of Economics, University of Toronto
Hao Li; Department of Economics, University of Toronto
Wing Suen; School of Economics and Finance, University of Hong Kong
Keywords: Signaling, credibility, individual rating, centralized rating, decentralized rating
C72, D82
Issue Date: 1-Sep-2008
Publisher: Theoretical Economics
Citation: Theoretical Economics; Vol 3, No 3 (2008)
Abstract: [This item is a preserved copy. To view the original, visit http://econtheory.org/] This paper considers a model of a rating agency with multiple clients, in which each client has a separate market that forms a belief about the quality of the client after the agency issues a rating. When the clients are rated separately (individual rating), the credibility of a good rating in an inflationary equilibrium of the signaling game is limited by the incentive of the agency to exaggerate the quality of the client. In centralized rating, the agency rates all clients together and shares the rating information among all markets. This allows the agency to coordinate the ratings and achieve a higher average level of credibility for its good ratings than in individual rating. In decentralized rating, the ratings are again shared among all markets, but each client is rated by a self-interested rater of the agency with no access to the quality information of other clients. When the underlying qualities of the clients are correlated, decentralized rating leads to a smaller degree of rating inflation and hence a greater level of credibility than in individual rating. Comparing centralized rating with decentralized rating, we find that centralized rating dominates decentralized rating for the agency when the underlying qualities are weakly correlated, but the reverse holds when the qualities are strongly correlated.
URI: http://hdl.handle.net/1807/16626
Other Identifiers: http://econtheory.org/ojs/index.php/te/article/view/20080325
Rights: Authors who publish in <i>Theoretical Economics</i> will release their articles under the <a href="http://creativecommons.org/licenses/by-nc/2.5/">Creative Commons Attribution-NonCommercial license</a>. This license allows anyone to copy and distribute the article for non-commercial purposes provided that appropriate attribution is given.
Appears in Collections:Volume 3, Number 3 (September 2008)

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