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Ratings Hardwiring and Asset Prices

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Abstract

This paper discusses the asset pricing implications of ratings hardwiring. The latter is defined as the mechanical response of trading decisions to changes in ratings. This issue is studied within a noisy rational expectations framework of asset pricing under asymmetric information in which traders specialize in different driving factors of asset payoffs and interact with others who mechanically link their asset supply to ratings. We show that ratings hardwiring leads to predictable supply shocks and induces informed traders to overreact to new information, thus creating a channel through which shocks are amplified and prices become less informative and more volatile.

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