How Much Do Investors Rely on Ratings? The Case of Mortgage Backed Securities

Posted: 25 Jun 2009 Last revised: 30 May 2015

See all articles by Manuel Adelino

Manuel Adelino

Duke University; Duke Innovation & Entrepreneurship Initiative; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Date Written: June 22, 2009

Abstract

This paper presents evidence that investors in residential mortgage backed securities (RMBS) did not rely exclusively on ratings but rather took the asset pool fundamentals into account when pricing these securities. Yield spreads at issuance have predictive power for future performance after taking into account the information contained in ratings, both in terms of downgrades and defaults. This holds for all rating classes in the period between 2003 and 2007 except for triple-A. This is consistent with the notion that triple-A rated classes behaved uniquely during this period and that investors did not apply to these tranches the same degree of due diligence as with other securities. When ratings and credit spreads disagree significantly about the ranking of securities in terms of their risk at the time of origination, spreads tend to predict future performance better than ratings (especially for lower ratings).

Keywords: Ratings, Spreads, Crisis

Suggested Citation

Adelino, Manuel, How Much Do Investors Rely on Ratings? The Case of Mortgage Backed Securities (June 22, 2009). Available at SSRN: https://ssrn.com/abstract=1425216

Duke Innovation & Entrepreneurship Initiative ( email )

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Durham, NC 27701
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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