Credit Ratings and Structured Finance

44 Pages Posted: 19 Feb 2019

See all articles by Jens Josephson

Jens Josephson

Stockholm University; Research Institute of Industrial Economics (IFN)

Joel D. Shapiro

University of Oxford - Said Business School

Multiple version iconThere are 2 versions of this paper

Date Written: February 2019

Abstract

The poor performance of credit ratings of structured finance products in the financial crisis has prompted investigation into the role of credit rating agencies (CRAs) in designing and marketing these products. We analyze a two-period reputation model in which a CRA both designs and rates securities that are sold both to investors who are constrained to purchase highly rated securities and investors who are unconstrained. Assets are pooled and senior and junior tranches are issued with a waterfall structure. When the rating constraint is lax, the CRA will include only risky assets in the securitization pool, serving both types of investors without any rating inflation. Rating inflation is decreasing in the tightness of the rating constraint locally. But rating inflation may be non-monotonic in the rating constraint globally, with no rating inflation when the constraint is lax or tight.

Keywords: Credit rating agencies, reputation, Structured finance

JEL Classification: G24, L14

Suggested Citation

Josephson, Jens and Shapiro, Joel D., Credit Ratings and Structured Finance (February 2019). CEPR Discussion Paper No. DP13534, Available at SSRN: https://ssrn.com/abstract=3336793

Jens Josephson (Contact Author)

Stockholm University ( email )

Sweden

Research Institute of Industrial Economics (IFN) ( email )

Box 55665
Grevgatan 34, 2nd floor
Stockholm, SE-102 15
Sweden

Joel D. Shapiro

University of Oxford - Said Business School ( email )

Park End Street
Oxford, OX1 1HP
Great Britain

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