The Impact of Beliefs on Credit Markets: Evidence from Rating Agencies


An open question in finance and economics is how the beliefs of agents affect the credit cycle and real economic activity. We analyze the impact of beliefs on credit markets in the context of credit rating agencies. We create a measure of rating agencies’ subjective beliefs based on the difference between their forecast of future aggregate credit spreads and the consensus of other financial institutions. When rating agencies become more optimistic, they issue higher credit ratings even though their forecasts do not predict future aggregate credit spreads. This optimism leads to lower initial yields and subsequent negative excess returns for newly issued bonds. Firms respond to this mispricing by increasing their debt, leverage, and investment. Finally, rating agencies become more optimistic as their head economists’ property values increase. Our analysis shows how subjective beliefs drive aggregate financing and investment behavior through mispricing in credit markets


Notre Dame, McGill, Peking University, SUFE, CICF 2022, AsianFA 2022, Office of the Comptroller of the Currency, Chinese University of Hong Kong, Shenzhen, University of Georgia, Boulder Summer Conference on Consumer Financial Decision Making, NFA 2023, AFA 2024