We analyze whether information asymmetry between issuers and investors leads to rating model arbitrage in Collateralized Debt Obligation markets. Rating model arbitrage is defined as the issuer''s deliberate capitalization of information asymmetry at the investor''s cost on the basis of different rating processes. Using data from CDO transactions grouped by both rating agencies and underlying rating methodologies, we test for homogeneity of characteristic transaction features within the group and heterogeneity between the different groups. We find that the hypothesis stating non-existence of rating model arbitrage on the basis of information asymmetry does not hold as individual patterns of transaction characteristics within each group could be identified.
The authors analyze whether multiple ratings for CDO tranches have an impact on credit spreads and examine the various effects with regard to the number of rating agencies involved. Based on a data set of more than 5,000 CDO tranches, the authors calculate index-adjusted credit spreads to isolate the specific credit risk per CDO tranche and find a negative correlation between number of ratings and credit spreads per CDO tranche-i.e., additional ratings are accompanied by lower credit spreads. On the basis of a valuation model, the authors show that multiple ratings are a significant pricing factor and conclude that investors demand an extra risk premium due to information asymmetries between CDO issuers and investors. Any additional rating reveals incremental information to the market and increases transparency with regard to the underlying portfolio's credit risk. However, the study does not find empirical support for the hypothesis that marginal tranche spread reduction decreases when additional rating agencies are added. Finally, the study finds evidence that second or third ratings by Fitch on average are higher when directly compared with Moody's and/or S&P ratings per CDO tranche. This finding is in line with existing literature on corporate bonds and indicates a bias also on CDO ratings due to their solicited character.
Anhand einer Principal-Agent-Betrachtung sowie den Resultaten eines Forschungsprojektes der Universität St. Gallen interpretieren die Autoren die aktuellen Vorschläge zur Anpassung der Geschäftsmodelle der Ratingagenturen. Auf der Grundlage ihrer empirischen Forschungsergebnisse halten sie es für belegbar, dass Emittenten ihren Informationsvorsprung aus dem Dialog mit den Ratingagenturen zum eigenen Vorteil nutzen und diesen zulasten der Investoren kapitalisieren. Um mehr Transparenz zu schaffen und einer Rating-Model-Arbitrage entgegenzuwirken, legen sie den Agenturen nahe, viel mehr auch als Agent der Investoren und nicht nur als Agent der Emittenten zu agieren.
We empirically investigate why issuers solicit and pay for multiple ratings not only at issuance but also during the monitoring phase of a debt instrument. Using monthly credit rat-ing migration data from Fitch, Moody's and Standard & Poor's on all U.S. residential mort-gage-backed securities from 1985 to 2012 ever rated (154'600 individual tranches), our results provide empirical evidence that rating agencies put more effort in rating and outlook revisions when tranches have assigned multiple ratings. Further, we demonstrate that in the case of multiple ratings, agencies do a better job in discriminating tranches with respect to default risk. Our results contribute to the literature on information production of credit ratings and extend the perspective to the monitoring period after issuance. We also show that in case of multiple ratings, Moody's on average provides the most conservative credit assessment and that this relative pattern remains consistent over a tranche's lifetime.
We empirically investigate the benefits of multiple ratings not only at issuance of debt instruments but also during the subsequent monitoring phase. Using a record of monthly credit rating migration data on all U.S. residential mortgage-backed securities rated by Standard & Poor's, Moody's, and Fitch between 1985 and 2012 (154'600 tranches), our results provide em-pirical evidence that rating agencies put more effort in rating and outlook revisions when tranches have assigned multiple ratings. Furthermore, we demonstrate that in the case of mul-tiple ratings, agencies do a better job in discriminating tranches with respect to default risk. On the downside, we observe a shift in collateral towards senior tranches and incentives for issuers to engage in rating shopping activities, but find no evidence that rating agencies exploit such behavior to attract more rating business. Our results contribute to the literature on information production of credit ratings and extend the perspective to the monitoring period after issuance.
We compare liquidity patterns of 10,979 failed and non-failed US banks from 2001 to mid-2010 and detect diverging capital structures: failing banks distinctively change their liquidity position about three to five years prior to default by increasing liquid assets and decreasing liquid liabilities. The build-up of liquid assets is primarily driven by short term loans, whereas long term loan positions are significantly reduced. By abandoning (positive) term transformation throughout the intermediate period prior to a default, failing banks drift away from the traditional banking business model. We show that this liquidity shift is induced by window dressing activities towards bondholders and money market investors as well as a bad client base.
