A necessary evolution: structure, problems and change, concepts for the credit rating industry

Abstract

This thesis explores the role of credit rating agencies (CRAs) on the financial market. The history, structure and business model of the rating industry will be examined, based on an extensive study of relevant literature, also including working papers and legislation by public authorities. Based on this overviews, it will be examined in how far external credit ratings of bad quality can have a destabilising influence on the markets and what might be the reasons for biased ratings. As a consequence it will be shown, that conflicts of interest, together with related dynamics, do indeed factor into the ratings released by CRAs, which in turn deteriorates market stability. Building on this, various possible ways to address these concerns will be presented and evaluated. The ideas of a changed remuneration system for rating agencies, of an European intermediary rating platform and of supplementing external ratings in legislatory frameworks with market measures will be specifically discussed. These topics will then form the basis of an agent-based model in NetLogo. This model will be used to simulate the dynamics that credit ratings induce in the financial market as well as the potential impact of the reform concepts described in the preceding chapter. The evaluation of this simulation model and its results in context of the theoretical part of the paper will then form the conclusion of the thesis.