A Political Economy of GovernmentBonds: Convergence of State Government Bond Ratings,1973-2003.

Abstract: Given the recent history of scandals involving financial intermediaries, governing officials have increased scrutiny of rating agencies, such as Moody’s and S&P, to ensure that they are providing accurate information to investors, the public and governing officials. This paper argues that rating agencies have incentives to assign ratings based, in part, upon positive network externalities accruing to both raters and states. Rating agencies seek a reputation of competence and credibility at least equal to that of their rivals or else they will be at a competitive disadvantage. This suggests that there should be significant convergence in the bond ratings by different agencies. We theorize that the level of convergence between ratings agencies is contingent upon the consensus to use joint credit ratings from the dominant firms. First, we hypothesize that additional rivals in a small market create a stronger incentive for firms to protect their reputation, and thus make ratings that tend to converge with those of their rivals. This paper uses data from Moody’s and S&P state government general obligation bond ratings from 1970 to 2002. Unlike most other bond rating research, we use an interval indicator of bond ratings, average yield spread, to test several propositions. We use a variety of time series techniques to test the hypotheses that competitive pressures in financial intermediary markets result in converging ratings. [ABSTRACT FROM AUTHOR]