Herding Behavior and Rating Convergence among Credit Rating Agencies: Evidence from the Subprime Crisis

35 Pages Posted: 7 Mar 2014

See all articles by Stefano Lugo

Stefano Lugo

Utrecht University - School of Economics

Annalisa Croce

Polytechnic University of Milan - Dipartimento di Economia e Produzione

Robert W. Faff

University of Queensland

Date Written: December 6, 2013

Abstract

This paper assesses how the presence of rating actions and discordant evaluations by a different rival credit rating agency (CRA) affects the timing of downgrades and the likelihood of rating convergence in the aftermath of the subprime crisis. We analyse a large sample of subprime mortgage-backed securities issued between 1992 and 2007, controlling for various characteristics of the issues. We show that, while Fitch is on average the first mover, Moody’s and S&P perform more timely downgrades given a downgrade by the other main CRA than by Fitch, and influence the latter more than they are influenced by it. Neither Moody’s nor S&P react with more timely revisions in the presence of a more severe rating by Fitch, while the downgrade hazard of all three main CRAs significantly increases in the presence of a lower rating by Moody’s or S&P. We also find that the likelihood of having a rating convergence by July 2011 is significantly higher when Fitch rather than Moody’s or S&P assigns the less severe rating before the onset of the crisis. Observing equal ratings by July 2011 is instead equally likely for tranches jointly rated by Moody’s and S&P, regardless of the direction of previous rating disagreements. Our results are consistent with theoretical predictions on the role of reputation in explaining herding behavior among CRAs.

Keywords: credit rating agencies, reputation, subprime, herding, financial crisis

JEL Classification: G01, G14, G24, G38

Suggested Citation

Lugo, Stefano and Croce, Annalisa and Faff, Robert W., Herding Behavior and Rating Convergence among Credit Rating Agencies: Evidence from the Subprime Crisis (December 6, 2013). Available at SSRN: https://ssrn.com/abstract=2405411 or http://dx.doi.org/10.2139/ssrn.2405411

Stefano Lugo (Contact Author)

Utrecht University - School of Economics ( email )

Kriekenpitplein 21-22
Adam Smith Building
Utrecht, +31 30 253 7373 3584 EC
Netherlands

Annalisa Croce

Polytechnic University of Milan - Dipartimento di Economia e Produzione ( email )

Piazza Leonardo da Vinci, 32
Milan, 20133
Italy

Robert W. Faff

University of Queensland ( email )

St Lucia
Brisbane, Queensland 4072
Australia

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