Did Subjectivity Play a Role in CDO Credit Ratings?
Journal of Finance, Forthcoming
54 Pages Posted: 22 Mar 2009 Last revised: 23 Feb 2012
Date Written: July 27, 2011
Analyzing 916 CDOs, we find that a top credit rating agency frequently made positive adjustments beyond its main model that amounted to 12.1% larger AAA tranche sizes. These adjustments are difficult to explain by likely determinants, but exhibit a clear pattern: CDOs with smaller model-implied AAA sizes receive larger adjustments. CDOs with larger adjustments experience more severe subsequent downgrading. Additionally, prior to April 2007, 91.2% of AAA rated CDOs only comply with the credit rating agency’s own AA default rate standard. Accounting for adjustments and the criterion deviation indicates that AAA tranches were on average structured to BBB support levels.
Keywords: CDO, Credit Rating
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