Credit ratings and structured finance |
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| Affiliation: | 1. Stockholm University, 106 91 Stockholm, Sweden, and Research Institute of Industrial Economics, Box 55665, 112 15 Stockholm, Sweden;2. Saïd Business School, University of Oxford, Park End Street, Oxford OX1 1HP, UK;1. Cass Business School, London, United Kingdom;2. CEPR, United Kingdom;3. Bank for International Settlements, Basel, Switzerland;1. D’Amore-McKim School of Business, Northeastern University, USA;2. Olin Business School, Washington University in St. Louis, USA;1. University of Duisburg-Essen, Lotharstr. 65, 47057 Duisburg, Germany;2. Brazilian School of Public and Business Administration, Getulio Vargas Foundation, Rua Jornalista Orlando Dantas 30, 22231-010 Rio de Janeiro, Brazil;3. Braunschweig Institute of Technology, Abt-Jerusalem-Str. 7, 38106 Braunschweig, Germany;1. Bank of Canada, 234 Wellington St, Ottawa, ON K1A 0G9, Canada;2. Centre for Economic Policy Research, London, United Kingdom |
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| Abstract: | The poor performance of credit ratings of structured finance products in the financial crisis has prompted investigation into the role of credit rating agencies (CRAs) in designing and marketing these products. We analyze a two-period reputation model in which a CRA both designs and rates securities that are sold both to investors who are constrained to purchase highly rated securities and investors who are unconstrained. Assets are pooled and senior and junior tranches are issued with a waterfall structure. When the rating constraint is lax, the CRA will include only risky assets in the securitization pool, serving both types of investors without any rating inflation. Rating inflation is decreasing in the tightness of the rating constraint locally. But rating inflation may be non-monotonic in the rating constraint globally, with no rating inflation when the constraint is lax or tight. |
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