Why they keep missing : an empirical investigation of rational inattention of rating agencies

Although there is a wide consensus that rating agencies have frequently failed to predict major crises, the literature on sovereign ratings has so far mostly focused on explaining the rating level rather than explaining the timing of the rating decision. In this paper we aim to fill this gap in the literature. Moreover, we go beyond the previous literature by explicitly differentiating between a decision to assess a country and the actual rating decision. Thereby, we take rational inattention of rating agencies into account that should exist due to the cognitive and informational costs of a reassessment. Exploiting information of rating announcements, we can show that (i) the differentiation between the two decision processes significantly improves the model explaining rating decisions; (ii) rating agencies take many nonfundamental factors in their decision to reassess a country into account; (iii) markets only react to ratings if these ratings supply genuinely new information; and (iv) that developed country get preferential treatment.