Rating Shopping or Catering? An Examination of the Response to Competitive Pressure for CDO Credit Ratings

Abstract

We examine whether “rating shopping” or “rating catering” is a more accurate characterization of rating agency interactions regarding collateralized debt obligations (CDOs) prior to the credit crisis. Although investors paid a premium for dual-ratings, AAA CDO tranches rated by both Moody’s and S&P defaulted more frequently than tranches rated by only one of them, which is inconsistent with pure rating shopping. Even though AAA-rated tranche sizes were typically identical, there was considerable disagreement between S&P’s and Moody’s assumptions on default correlations and even collateral quality. Rating agencies made upward adjustments beyond their model outputs when their competitor had more lenient assumptions. Finally, although S&P’s and Moody’s adjustments and disagreements were not reflected in yields at issuance, they were reflected in subsequent rating downgrades, suggesting that rating agencies later reverted towards their initial models.

JEL Classification: G01, G28