Working Paper: CEPR ID: DP9465
Authors: Matthias Efing; Harald Hau
Abstract: This paper tests for conflicts of interest in the rating process of European asset- and mortgage-backed securities based on a new aggregation method for a deal's different tranche ratings. Controlling for a large set of determinants of credit risk, we find that credit rating agencies provide better credit ratings for the structured products of those issuers that provide them with more overall bilateral rating business. This effect is particularly pronounced in the run-up to the subprime crisis and for structured products with the worst collateral. Rating favors to the largest clients generate economically significant competitive distortion, foster issuer concentration and contribute to the "too big to fail" status of large issuer banks.
Keywords: conflicts of interest; credit ratings; ratings inflation; structured debt
JEL Codes: G01; G10; G24
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Agency-specific securitization business (ASSB) (G32) | Rating favors (Y30) |
| Agency-specific securitization business (ASSB) (G32) | Deal rating-implied spread (DRIS) (G24) |
| Rating favors (Y30) | Deal rating-implied spread (DRIS) (G24) |
| Agency-specific securitization business (ASSB) (G32) | Inflated ratings (E31) |
| Rating favors (Y30) | Distortion in credit rating process (G21) |
| Rating favors vary over the credit cycle (E43) | Rating favors are more significant during credit booms (E44) |
| Ratings shopping (G24) | Better ratings for deals rated by a single CRA (G24) |