How Much Do Investors Rely on Ratings? The Case of Mortgage Backed Securities
Posted: 25 Jun 2009 Last revised: 30 May 2015
Date Written: June 22, 2009
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
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