Research On Inflate Rating Behavior Of CRAs

From2008financial crisis to EU debt crisis, the credit rating agencies have faded in people’s sight. As the result of the devastating effects of crisis, people now become more aware of the role of credit rating agencies (CRAs) and their inflate rating actions.As an important participant in the financial markets, CRAs have the responsibility to analysis the default risk of the bond issuer to make professional and objective judgments, their conclusion is important and even the only basis for investors to make decisions. But CRAs have been highly criticized for their failure in the crisis, they failed to forecast the financial crisis and EU debt crisis, not to mention helping avoid all these. And maybe it is just the inflated rating that boosts the crisis.But why do CRAs inflate ratings and what are the intrinsic motivations? In this article, we established the game model among the rating agencies, issuers, and investors, and also selected three major conflicts of interest:1) the CRA conflict of interest of understating credit risk to attract more business;2) the issuer usually buys the most favorable rating;3) investors want to purchase rating at face value. We show that when combined, these give rise to three fundamental equilibrium distortions. First, competition among CRAs can reduce market efficiency, as competition facilitates ratings shopping by issuers. Second, CRAs are more prone to inflate ratings in boom times, when there are more trusting investors, and when the risks of failure which could damage CRA reputation are lower. Third, the industry practice of tranching of structured products distorts market efficiency as its role is to deceive trusting investors. On account of the loss of market efficiency and investment risk that inflated rating cause, we analysis the Chinese rating industry status quo and existed problems, then put up with the path of the rating industry development in China and the policy suggestions, based on reforms of the supervision on international rating agencies.