Stress test analysis on ratings quality over the business cycle

Abstract

This research thesis is based on a theoretical model that analysed how a CRAs’ incentives to provide ratings of high quality vary depending on which economic cycle (boom or recession) exists. From the results it appears that ratings quality is lower during booms than during recessions. This is known as the counter-cyclicality of ratings and is due to incentives to milk a reputation. A distinction is also made between a monopoly and a duopoly and it is clear that in both cases the counter-cyclical ratings quality holds. The aim of this master’s thesis is to analyse by means of a stress test how this model is sensitive to a modification of three parameters. The three parameters are gamma which is the parameter that captures labor-market conditions, lambda that is the probability that an investment is good and tau that is the probability of a transition from the current state to another one. Again, a distinction is made between a monopoly and a duopoly.