Francesco Sangiorgi

Bio: Francesco Sangiorgi is an academic researcher from Frankfurt School of Finance & Management. The author has contributed to research in topics: Credit rating & Bond credit rating. The author has an hindex of 12, co-authored 25 publications receiving 730 citations. Previous affiliations of Francesco Sangiorgi include Pompeu Fabra University & Stockholm School of Economics.

Credit-Rating Shopping, Selection and the Equilibrium Structure of Ratings

Abstract: An important feature of the microstructure of credit ratings is the ability of a security issuer to choose which ratings to purchase. Such choices can reflect explicit or even implicit shopping for favorable credit reviews and induce "selection" effects in the structure of ratings. When there is considerable heterogeneity in views the issuer selects the ratings that are the most positive. Because the correlation among models is least when heterogeneity is greatest, we examine the influence of the correlation on the extent of ratings shopping and bias. Selectivity is central to the decision to solicit (purchase) a credit rating or for the credit rating agency to provide an unsolicited rating based upon coarser information. Our analysis highlights the interaction between the decision about whether to rely on unsolicited ratings and the potential for ratings shopping, illustrating the interaction between different types of potential conflicts of interest in the credit rating process. We use selection to provide an equilibrium interpretation for "notching" (formulaic haircutting of a credit rating agency's rating) by a rival. We point to the potential winner's curse that is implicit when the most favorable rating is selected, raising the issue of how rating agencies, regulatory authorities and investors interpret solicited ratings. We conclude by presenting theoretical results and numerical solutions to illustrate qualitative aspects of rating shopping. For example, we show that higher cost of obtaining indicative ratings and regulatory mandates to charge fees for obtaining indicative ratings reduce the extent to which these are obtained, increasing the extent of ratings bias. The higher cost of ratings also reduces the probability of "notching," i.e., the likelihood that an unpublished rating is below an existing published one.

Overconfidence and Market Efficiency with Heterogeneous Agents

Abstract: We study financial markets in which both rational and overconfident agents coexist and make endogenous information acquisition decisions. We demonstrate the following irrelevance result when a positive fraction of rational agents (endogenously) decides to become informed in equilibrium, prices are set as if all investors were rational, and as a consequence the overconfidence bias does not affect informational efficiency, price volatility, rational traders’ expected profits or their welfare. Intuitively, as overconfidence goes up, so does price informativeness, which makes rational agents cut their information acquisition activities, effectively undoing the standard effect of more aggressive trading by the overconfident. The main intuition of the paper, if not the irrelevance result, is shown to be robust to different model specifications.

Overconfidence and market efficiency with heterogeneous agents

Abstract: We study financial markets in which both rational and overconfident agents coexist and make endogenous information acquisition decisions. We demonstrate the following irrelevance result: when a positive fraction of rational agents (endogeneously) decides to become informed in equilibrium, prices are set as if all investors were rational, and as a consequence the overconfidence bias does not a ect informational efficiency, price volatility, rational traders’ expected profits or their welfare. Intuitively, as overconfidence goes up, so does price infornativeness, which makes rational agents cut their information acquisition activities, effectively undoing the standard effect of more aggressive trading by the overconfident.

Uncertainty, Information Acquisition and Price Swings in Asset Markets

Abstract: This paper analyzes costly information acquisition in asset markets with Knightian uncertainty about the asset fundamentals. In these markets, acquiring information not only reduces the expected variability of the fundamentals for a given distribution (i.e., risk). It also mitigates the uncertainty about the true distribution of the fundamentals. Agents who lack knowledge of this distribution cannot correctly interpret the information other investors impound into the price. We show that, due to uncertainty aversion, the incentives to reduce uncertainty by acquiring information increase as more investors acquire information. When uncertainty is high enough, information acquisition decisions become strategic complements and lead to multiple equilibria. Swift changes in information demand can drive large price swings even after small changes in Knightian uncertainty.

Uncertainty, Information Acquisition and Price Swings in Asset Markets

Abstract: This paper studies asset markets in which ambiguity averse investors face Knightian uncertainty about the fundamentals, and coexist with agents who have resolved their uncertainty, although not risk, as a result of a rational information acquisition process. In these markets, there are complementaries in information acquisition (the larger the number of informed agents, the higher the incentives for anyone else to become informed), multiplicity of equilibria, history-dependent prices, and large price swings occurring after small changes in the uncertainty surrounding the assets fundamentals. Our model predicts the typical market response to an uncertainty shock: a crash, followed by a sustained rally, which the model generates due to the information complementarities. Our model highlights uncertainty as a new channel for episodes of extreme price volatility, media frenzies and neglects.

The Trouble With Overconfidence

Abstract: This paper presents a reconciliation of the three distinct ways in which the research literature has defined overconfidence: (1) overestimation of one's actual performance, (2) overplacement of one's performance relative to others, and (3) excessive precision in one's beliefs. Experimental evidence shows that reversals of the first two (apparent underconfidence), when they occur, tend to be on different types of tasks. On difficult tasks, people overestimate their actual performances but also believe that they are worse than others; on easy tasks, people underestimate their actual performances but believe they are better than others. This paper offers a straightforward theory that can explain these inconsistencies. Overprecision appears to be more persistent than either of the other two types of overconfidence, but its presence reduces the magnitude of both overestimation and overplacement.

The Trouble With Overconfidence

Abstract: The authors present a reconciliation of 3 distinct ways in which the research literature has defined overconfidence: (a) overestimation of one's actual performance, (b) overplacement of one's performance relative to others, and (c) excessive precision in one's beliefs. Experimental evidence shows that reversals of the first 2 (apparent underconfidence), when they occur, tend to be on different types of tasks. On difficult tasks, people overestimate their actual performances but also mistakenly believe that they are worse than others; on easy tasks, people underestimate their actual performances but mistakenly believe they are better than others. The authors offer a straightforward theory that can explain these inconsistencies. Overprecision appears to be more persistent than either of the other 2 types of overconfidence, but its presence reduces the magnitude of both overestimation and overplacement.

Theory and Experiment

Abstract: This paper studies the impact of ambiguity and ambiguity aversion on equilibrium asset prices and portfolio holdings in competitive financial markets. It argues that attitudes toward ambiguity are heterogeneous across the population, just as attitudes toward risk are heterogeneous across the population, but that heterogeneity of attitudes toward ambiguity has different implications than heterogeneity of attitudes toward risk. In particular, when some state probabilities are not known, agents who are sufficiently ambiguity averse find open sets of prices for which they refuse to hold an ambiguous portfolio. This suggests a different cross-section of portfolio choices, a wider range of state price/probability ratios and different rankings of state price/probability ratios than would be predicted if state probabilities were known. Experiments confirm all of these suggestions. Our findings contradict the claim that investors who have cognitive biases do not affect prices because they are infra-marginal: ambiguity averse investors have an indirect effect on prices because they change the per-capita amount of risk that is to be shared among the marginal investors. Our experimental data also suggest a positive correlation between risk aversion and ambiguity aversion that might explain the “value effect” in historical data.

The Credit Ratings Game

Abstract: The collapse of so many AAA-rated structured finance products in 2007-2008 has brought renewed attention to the causes of ratings failures and the conflicts of interest in the Credit Ratings Industry. We provide a model of competition among Credit Ratings Agencies (CRAs) in which there are three possible sources of conflicts: 1) the CRA conflict of interest of understating credit risk to attract more business; 2) the ability of issuers to purchase only the most favorable ratings; and 3) the trusting nature of some investor clienteles who may take ratings at face value. We show that when combined, these give rise to three fundamental equilibrium distortions. First, competition among CRAs can reduce market efficiency, as competition facilitates ratings shopping by issuers. Second, CRAs are more prone to inflate ratings in boom times, when there are more trusting investors, and when the risks of failure which could damage CRA reputation are lower. Third, the industry practice of tranching of structured products distorts market efficiency as its role is to deceive trusting investors. We argue that regulatory intervention requiring: i) upfront payments for rating services (before CRAs propose a rating to the issuer), ii) mandatory disclosure of any rating produced by CRAs, and iii) oversight of ratings methodology can substantially mitigate ratings inflation and promote efficiency.