Improving The Efficiency Of The Market

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To improve the efficiency of the market, CRAs act as reliable information providers to collect and process information pertinent for the assessment of credit quality, and disseminate the results to financial market participants such as investors and portfolio managers. The rating information provided by CRAs will reduce information asymmetries in the market, and this will lead to a higher level of investor confidence, increased activities in the market and lower transaction costs. To begin with, information asymmetry refers to a situation in which the issuer of a debt instrument who is the borrower has more knowledge about its own creditworthiness than the investors who are creditors. This information asymmetry discourages investors…show more content…
A downgrade will only occur in the event of major changes in the issuer’s financial status, which means that a rating will not be reviewed frequently. The credit rating assists in providing the issuer with a broader range of financing opportunities in a manner that is more efficient than in traditional loan banking. In this way, the transaction costs are lower and the pools of investors are larger. A rating also has influence on the interest rate of securities since highly-rated issuers have to pay less interest to compensate the risk of investors. Undoubtedly, both private and institutional investors are likely to depend on credit ratings as a standard to assist them in making more knowledgeable investment decisions. It is the same for portfolio managers who can use rating as guidance when they have to deal with a wide range of financial products originating from different countries. Furthermore, credit ratings can be beneficial for other problems, especially the issue of collective action among dispersed debt investors, and the issue of principal-agent between investors and their agents. It may not be possible for a single bond investor to observe the performance of a corporation during a difficult period of time. If a company carries on its business without any measures being taken, the values that investors are entitled to recover could be reduced. A downgrade of credit rating by CRAs can serve as a warning for investors to
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