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Market Dynamics Associated with Credit Ratings: A Literature Review

by Fernando Gonzalez of the European Central Bank,
Franšois Haas of the Banque De France,
Ronald Johannes of the Bank Of England,
Mattias Persson of Sveriges Riksbank,
Liliana Toledo of the Banco De Espa˝a,
Roberto Violi of the Banca D'italia
Carmen Zins of Deutsche Bundesbank, and
Martin Wieland of Deutsche Bundesbank

June 2004

Introduction: This paper summarises the work conducted by a group of economists from various European central banks over the summer of 2003. It is intended to add to the ongoing debate on major rating agencies and their methodologies. The analysis and policy considerations proposed are based on a review of the literature and are those of the authors; they do not necessarily reflect the positions of their respective institutions.

The paper is aimed at contributing to the current debate on this topic in two ways: first, by providing a factual exposition of the significance and evolving use of credit ratings in the financial markets and, second, by identifying the possible impacts that such evolving use may have on market dynamics (i.e. the timing and path of asset price adjustments, the dynamics of credit spreads, the potential magnifying effects that rating changes can trigger) and analysing how credit rating agencies (CRAs) have responded to the increasing, and sometimes conflicting, demands that market participants put on credit ratings. In doing so, the paper also provides a comprehensive review of literature on credit ratings and CRAs.

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