Can Reputation Ensure Efficiency in the Structured Finance Market? Majority Voting: A Quantitative Investigation

26 Pages Posted: 1 Jan 2016

See all articles by Mahmoud Elamin

Mahmoud Elamin

Federal Reserve Bank of Cleveland

Date Written: 2015-01-07

Abstract

In Elamin (2013), the credit rating agency (CRA) cannot credibly fully reveal its information about the quality of a rated structured finance project, when ratings are unverifiable. Can the fear of losing its reputation discipline the CRA? In this paper, there is incomplete information about the type of the CRA. With some probability, it can be a truthful type, always fully revealing its information. At every period, the (updated) probability that the CRA is of the truthful type is its reputation. With only two project types and when the CRA's reputation is high enough, an informationally efficient equilibrium, where investors are fully informed, exists. With more than two project types, no matter how high the CRA's patience level or its reputation, there is no informationally efficient equilibrium. The many-project-types case is clearly the relevant case; therefore, I conclude that the fear of losing a reputation is not enough of a deterrent in the structured finance market.

Keywords: Credit Rating Agencies, Conflicts of Interest, Reputation

JEL Classification: D8, G2

Suggested Citation

Elamin, Mahmoud, Can Reputation Ensure Efficiency in the Structured Finance Market? Majority Voting: A Quantitative Investigation (2015-01-07). FRB of Cleveland Working Paper No. 1441, Available at SSRN: https://ssrn.com/abstract=2708410

Mahmoud Elamin (Contact Author)

Federal Reserve Bank of Cleveland ( email )

East 6th & Superior
Cleveland, OH 44101-1387
United States

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