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Believe only what you see: credit rating agencies, structured finance, and bonds

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  • Mahmoud Elamin

Abstract

This paper identifies rating verifiability as a key difference that explains why credit rating agencies (CRAs) failed to mitigate information asymmetries in the structured finance market but succeeded in the bond market. Two infinitely repeated models are analyzed. In the first, the rating is unverifiable, and there is no equilibrium where the CRA reveals its information. In the second, the rating is verified with some probability, and full information revelation is guaranteed for any verification probability, when the CRA is patient enough. The interaction between verification probability and CRA patience is also analyzed.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Cleveland in its series Working Paper with number 1222.

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Date of creation: 2012
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Handle: RePEc:fip:fedcwp:1222

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Keywords: Financial institutions ; Uncertainty;

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  1. Efraim Benmelech & Jennifer Dlugosz, 2010. "The Credit Rating Crisis," NBER Chapters, in: NBER Macroeconomics Annual 2009, Volume 24, pages 161-207 National Bureau of Economic Research, Inc.
  2. Lawrence J. White, 2010. "Markets: The Credit Rating Agencies," Journal of Economic Perspectives, American Economic Association, American Economic Association, vol. 24(2), pages 211-26, Spring.
  3. Drew Fudenberg & Jean Tirole, 1991. "Game Theory," MIT Press Books, The MIT Press, The MIT Press, edition 1, volume 1, number 0262061414, December.
  4. Patrick Bolton & Xavier Freixas & Joel Shapiro, 2009. "The credit ratings game," Economics Working Papers, Department of Economics and Business, Universitat Pompeu Fabra 1149, Department of Economics and Business, Universitat Pompeu Fabra.
  5. Carlson Mark & Hale Galina B, 2006. "Rating Agencies and Sovereign Debt Rollover," The B.E. Journal of Macroeconomics, De Gruyter, De Gruyter, vol. 6(2), pages 1-32, September.
  6. Mathis, Jérôme & McAndrews, James & Rochet, Jean-Charles, 2009. "Rating the raters: Are reputation concerns powerful enough to discipline rating agencies?," Journal of Monetary Economics, Elsevier, Elsevier, vol. 56(5), pages 657-674, July.
  7. Richard Cantor & Frank Packer, 1994. "The credit rating industry," Quarterly Review, Federal Reserve Bank of New York, Federal Reserve Bank of New York, issue Sum, pages 1-26.
  8. Mailath, George J. & Samuelson, Larry, 2006. "Repeated Games and Reputations: Long-Run Relationships," OUP Catalogue, Oxford University Press, Oxford University Press, number 9780195300796, October.
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