Did Subjectivity Play a Role in CDO Credit Ratings?

54 Pages Posted: 22 Mar 2009 Last revised: 23 Feb 2012

John M. Griffin

University of Texas at Austin - Department of Finance

Dragon Yongjun Tang

The University of Hong Kong - School of Economics and Finance

Date Written: July 27, 2011

Abstract

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

Suggested Citation

Griffin, John M. and Tang, Dragon Yongjun, Did Subjectivity Play a Role in CDO Credit Ratings? (July 27, 2011). Journal of Finance, Forthcoming; AFA 2010 Atlanta Meetings Paper; CELS 2009 4th Annual Conference on Empirical Legal Studies Paper; McCombs Research Paper Series No. FIN-04-10. Available at SSRN: https://ssrn.com/abstract=1364933

John M. Griffin

University of Texas at Austin - Department of Finance ( email )

Red McCombs School of Business
Austin, TX 78712
United States
512-471-6621 (Phone)

HOME PAGE: http://www.jgriffin.info

Dragon Yongjun Tang (Contact Author)

The University of Hong Kong - School of Economics and Finance ( email )

KKL 1005
Pokfulam Road
Pokfulam
Hong Kong
(852)22194321 (Phone)

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