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Publication Type
Conference Proceedings
Author, Analytic
King, Damien W; Tennant, David F; Tracey, Marlon R
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Paper/Section Title
Asymmetric Bias and Self-Fulfilling Sovereign Defaults
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Latin American and Caribbean Economic Association Annual Conference
Date of Meeting
October 15-17, 2015
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Abstract
The recent literature on lapses in structured finance credit ratings has raised questions about possible ratings biases, and has reignited the debate as to the existence of such biases in sovereign credit ratings. We develop a theoretical model which shows that it is optimal for credit ratings agencies (CRAs) to be biased against poor countries in their sovereign debt ratings due to the CRAs’ disinclination to incur the higher cost of acquiring information in those countries. Empirical support for this bias is demonstrated, as we show that S&P, Moody’s and Fitch are more reluctant to upgrade poor countries relative to rich countries, for any given favorable change in ability and willingness to pay debts. We then theoretically consider the implications of this bias and find that, in some cases, the consequence of such a bias against poor countries could constitute a sufficient condition to precipitate a default.....
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