Divergence in credit ratings

During the recent credit crisis credit rating agencies (CRAs) became increasingly lax in their rating of structured products, yet increasingly stringent in their rating of corporate bonds. We examine a model in which a CRA operates in both the market for structured products and for corporate debt, and shares a common reputation across the two markets. We find that, as a CRA's reputation becomes good enough, it can be optimal for it to inflate its ratings with probability one in the structured products market, but inflate its ratings with probability zero in the corporate bond market.

► Credit rating behavior prior to the 2008 crash was divergent. ► Bond ratings became more conservative, structured product ratings more lax. ► We model rating behavior when a monopoly CRA operates in both markets. ► A CRA's reputation is affected by rating quality in both markets. ► Reputational spillover effects can drive divergent rating behavior across markets.