Credit ratings and liquidity crises

Abstract

This paper examines the effects of information dissemination by a credit rating agency (CRA) on a liquidity crisis. In our proposed model, the CRA and creditors share public information on a firm's repayment ability. In addition, the CRA and creditors obtain noisy private information about the firm. After receiving its private information, the CRA announces it to creditors along with its opinion. We find that the probability of the firm having a liquidity crisis does not always decrease with the accuracy of the CRA's information. Moreover, if the CRA has reputation concerns, CRA opinions that contain inaccurate information rely more on the market prior.