Abstract
Financial crises, municipal bankruptcies, and fear of contagious sovereign default have raised questions about the competency and character of politicians and public managers, but the credibility of private sector credit rating agencies and bond ratings may be the more relevant target of scrutiny. This article examines the credibility of government bond ratings in light of market institutions creating incentives to inflate ratings. Using yield spreads as interval indicators of bond ratings and historical ratings of state general obligation (GO) bonds from 1975 to 2002, a Granger-causality and vector autoregression analysis of the average ratings in the Moody’s and Standard and Poor’s portfolio of state GO bond ratings indicate that ratings are sensitive to market dynamics. Such market endogeneity confirms concerns about the credibility of government bond ratings and points to the necessity of considering institutional reform in the bond rating market.
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