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The Procyclical Role of Rating Agencies: Evidence from the East Asian Crisis

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Keywords
  • Economics
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  • Economics

Abstract

We demonstrate that credit rating agencies aggravated the East Asian crisis. In fact, having jailed to predict the emergence of the crisis, rating agencies became excessively conservative. They downgraded East Asian crisis countries more than the worsening in these countries' economic fundamentals would justify. This unduly exacerbated, for these countries, the cost of borrowing abroad and caused the supply of international capital to them to evaporate. In turn, lower than deserved ratings contributed -- at least for some time -- to amplify the East Asian crisis. Although this goes beyond the scope of our paper we also propose an endogenous rationale for rating agencies to become excessively conservative after having made blatant errors in predicting the East Asian crisis. Specifically, rating agencies would have an incentive to become more conservative, so as to recover from the damage these errors caused to them and to rebuild their own reputation.

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