IDEAS home Printed from https://ideas.repec.org/p/red/sed019/1105.html
   My bibliography  Save this paper

Imperfect Information Transmission from Banks to Investors: Macroeconomic Implications

Author

Listed:
  • Nicolas Figueroa

    (Pontificia Universidad Catolica de Chile)

  • CARLOS RAMIREZ

    (FEDERAL RESERVE BOARD)

  • Oksana Leukhina

    (Federal Reserve Bank of St Louis - Research Division)

Abstract

We study the interaction of information transmission in loan-backed asset markets and screening effort in a general equilibrium framework. Originating banks can screen their borrowers, but can inform investors of their asset type only through an error-prone rating technology. The premium paid on highly rated assets emerges as the main determinant of screening effort. Because the rating technology is imperfect, this premium is insufficient to induce the efficient level of screening. However, the fact that banks know their asset quality and produce public information accordingly helps keep the premium high. Mandatory rating and mandatory ratings disclosure policies interfere with this decision margin, thereby reducing informativeness of high ratings, lowering the premium paid on them, and exacerbating the credit misallocation problem. Policies that work to increase accuracy and/or cost of rating technology can help restore efficiency. If, as in Skreta and Veldkamp (2009), we associate the expansion leading up to the recent financial crisis with declining rating accuracy, our model helps interpret several puzzling pre-crisis observations: laxer screening effort, intensified rating activity, ratings inflation, the decline in the premium paid on highly rated assets, and rising prevalence of triple-A ratings. The same model mechanism also helps explain the variation in default rates across asset classes documented in Cornaggia, Cornaggia, and Hund (2017).

Suggested Citation

  • Nicolas Figueroa & CARLOS RAMIREZ & Oksana Leukhina, 2019. "Imperfect Information Transmission from Banks to Investors: Macroeconomic Implications," 2019 Meeting Papers 1105, Society for Economic Dynamics.
  • Handle: RePEc:red:sed019:1105
    as

    Download full text from publisher

    File URL: https://red-files-public.s3.amazonaws.com/meetpapers/2019/paper_1105.pdf
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Lown, Cara & Morgan, Donald P., 2006. "The Credit Cycle and the Business Cycle: New Findings Using the Loan Officer Opinion Survey," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(6), pages 1575-1597, September.
    2. Anil K. Kashyap & Natalia Kovrijnykh, 2016. "Who Should Pay for Credit Ratings and How?," The Review of Financial Studies, Society for Financial Studies, vol. 29(2), pages 420-456.
    3. David Andolfatto & Fernando Martin, 2013. "Information Disclosure and Exchange Media," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 16(3), pages 527-539, July.
    4. Bengt Holmstrom & Jean Tirole, 1997. "Financial Intermediation, Loanable Funds, and The Real Sector," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 112(3), pages 663-691.
    5. Skreta, Vasiliki & Veldkamp, Laura, 2009. "Ratings shopping and asset complexity: A theory of ratings inflation," Journal of Monetary Economics, Elsevier, vol. 56(5), pages 678-695, July.
    6. Patrick Bolton & Xavier Freixas & Joel Shapiro, 2012. "The Credit Ratings Game," Journal of Finance, American Finance Association, vol. 67(1), pages 85-112, February.
    7. Boyd, John H. & Prescott, Edward C., 1986. "Financial intermediary-coalitions," Journal of Economic Theory, Elsevier, vol. 38(2), pages 211-232, April.
    8. Raghuram G. Rajan, 1994. "Why Bank Credit Policies Fluctuate: A Theory and Some Evidence," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 109(2), pages 399-441.
    9. Christine A. Parlour & Guillaume Plantin, 2008. "Loan Sales and Relationship Banking," Journal of Finance, American Finance Association, vol. 63(3), pages 1291-1314, June.
    10. Atif Mian & Amir Sufi, 2009. "The Consequences of Mortgage Credit Expansion: Evidence from the U.S. Mortgage Default Crisis," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 124(4), pages 1449-1496.
    11. Gary Gorton, 2009. "Information, Liquidity, and the (Ongoing) Panic of 2007," American Economic Review, American Economic Association, vol. 99(2), pages 567-572, May.
    12. Peter M. DeMarzo, 2005. "The Pooling and Tranching of Securities: A Model of Informed Intermediation," The Review of Financial Studies, Society for Financial Studies, vol. 18(1), pages 1-35.
    13. Vitaly M. Bord & João A.C. Santos, 2015. "Does Securitization of Corporate Loans Lead to Riskier Lending?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 47(2-3), pages 415-444, March.
    14. Christine Parlour & Guillaume Plantin, 2008. "Loan Sales and Relationship Banking," Post-Print hal-03415832, HAL.
    15. Berger, Allen N. & Udell, Gregory F., 2004. "The institutional memory hypothesis and the procyclicality of bank lending behavior," Journal of Financial Intermediation, Elsevier, vol. 13(4), pages 458-495, October.
    16. Hirshleifer, Jack, 1971. "The Private and Social Value of Information and the Reward to Inventive Activity," American Economic Review, American Economic Association, vol. 61(4), pages 561-574, September.
    17. Kurlat, Pablo & Veldkamp, Laura, 2015. "Should we regulate financial information?," Journal of Economic Theory, Elsevier, vol. 158(PB), pages 697-720.
    18. Paul Povel & Rajdeep Singh & Andrew Winton, 2007. "Booms, Busts, and Fraud," The Review of Financial Studies, Society for Financial Studies, vol. 20(4), pages 1219-1254.
    19. 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, vol. 56(5), pages 657-674, July.
    20. Amiyatosh Purnanandam, 2011. "Originate-to-distribute Model and the Subprime Mortgage Crisis," The Review of Financial Studies, Society for Financial Studies, vol. 24(6), pages 1881-1915.
    21. Jess N. Cornaggia & Kimberly J. Cornaggia & John E. Hund, 2017. "Credit Ratings Across Asset Classes: A Long-Term Perspective," Review of Finance, European Finance Association, vol. 21(2), pages 465-509.
    22. 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.
    23. Benmelech, Efraim & Dlugosz, Jennifer, 2009. "The alchemy of CDO credit ratings," Journal of Monetary Economics, Elsevier, vol. 56(5), pages 617-634, July.
    24. Gorton, Gary B. & Pennacchi, George G., 1995. "Banks and loan sales Marketing nonmarketable assets," Journal of Monetary Economics, Elsevier, vol. 35(3), pages 389-411, June.
    25. Benjamin J. Keys & Amit Seru & Vikrant Vig, 2012. "Lender Screening and the Role of Securitization: Evidence from Prime and Subprime Mortgage Markets," The Review of Financial Studies, Society for Financial Studies, vol. 25(7), pages 2071-2108.
    26. John M. Griffin & Dragon Yongjun Tang, 2011. "Did Credit Rating Agencies Make Unbiased Assumptions on CDOs?," American Economic Review, American Economic Association, vol. 101(3), pages 125-130, May.
    27. Benjamin J. Keys & Tanmoy Mukherjee & Amit Seru & Vikrant Vig, 2010. "Did Securitization Lead to Lax Screening? Evidence from Subprime Loans," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 125(1), pages 307-362.
    28. Opp, Christian C. & Opp, Marcus M. & Harris, Milton, 2013. "Rating agencies in the face of regulation," Journal of Financial Economics, Elsevier, vol. 108(1), pages 46-61.
    29. Beltran, Daniel O. & Cordell, Larry & Thomas, Charles P., 2017. "Asymmetric information and the death of ABS CDOs," Journal of Banking & Finance, Elsevier, vol. 76(C), pages 1-14.
    30. Steven Shavell, 1994. "Acquisition and Disclosure of Information Prior to Sale," RAND Journal of Economics, The RAND Corporation, vol. 25(1), pages 20-36, Spring.
    31. Sivan Frenkel, 2015. "Repeated Interaction and Rating Inflation: A Model of Double Reputation," American Economic Journal: Microeconomics, American Economic Association, vol. 7(1), pages 250-280, February.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Brendan Daley & Brett Green & Victoria Vanasco, 2020. "Securitization, Ratings, and Credit Supply," Journal of Finance, American Finance Association, vol. 75(2), pages 1037-1082, April.
    2. Deku, Solomon Y. & Kara, Alper & Zhou, Yifan, 2019. "Securitization, bank behaviour and financial stability: A systematic review of the recent empirical literature," International Review of Financial Analysis, Elsevier, vol. 61(C), pages 245-254.
    3. Fenner, Arved & Klein, Philipp & Mössinger, Carina, 2021. "Better be careful: The replenishment of ABS backed by SME loans," Discussion Papers 30/2021, Deutsche Bundesbank.
    4. Patir, Assaf, 2017. "Securitization, bank vigilance, leverage and sudden stops," MPRA Paper 81463, University Library of Munich, Germany.
    5. Kara, Alper & Marques-Ibanez, David & Ongena, Steven, 2016. "Securitization and lending standards: Evidence from the European wholesale loan market," Journal of Financial Stability, Elsevier, vol. 26(C), pages 107-127.
    6. Wenming Xu & Yan Liu, 2021. "Does reputational capital affect credit rating agencies?: empirical evidence from a natural experiment in China," European Journal of Law and Economics, Springer, vol. 51(3), pages 433-468, June.
    7. Ahn, Jung-Hyun & Breton, Régis, 2014. "Securitization, competition and monitoring," Journal of Banking & Finance, Elsevier, vol. 40(C), pages 195-210.
    8. Kara, A. & Marques-Ibanez, D. & Ongena, S., 2011. "Securitization and Lending Standards : Evidence from the Wholesale Loan Market," Other publications TiSEM d82c3ad1-2bb3-4108-80cd-0, Tilburg University, School of Economics and Management.
    9. Alper Kara & David Marques-Ibanez & Steven Ongena, 2015. "Securitization and Credit Quality," Working Papers 15013, Bangor Business School, Prifysgol Bangor University (Cymru / Wales).
    10. Kuncl, Martin, 2019. "Securitization under asymmetric information over the business cycle," European Economic Review, Elsevier, vol. 111(C), pages 237-256.
    11. Efing, Matthias & Hau, Harald, 2015. "Structured debt ratings: Evidence on conflicts of interest," Journal of Financial Economics, Elsevier, vol. 116(1), pages 46-60.
    12. Jess N. Cornaggia & Kimberly J. Cornaggia & John E. Hund, 2017. "Credit Ratings Across Asset Classes: A Long-Term Perspective," Review of Finance, European Finance Association, vol. 21(2), pages 465-509.
    13. Matthieu Bouvard & Raphaël Levy, 2018. "Two-Sided Reputation in Certification Markets," Management Science, INFORMS, vol. 64(10), pages 4755-4774, October.
    14. Jeon, Doh-Shin & Lovo, Stefano, 2013. "Credit rating industry: A helicopter tour of stylized facts and recent theories," International Journal of Industrial Organization, Elsevier, vol. 31(5), pages 643-651.
    15. Roman Inderst & Sebastian Pfeil, 2013. "Securitization and Compensation in Financial Institutions," Review of Finance, European Finance Association, vol. 17(4), pages 1323-1364.
    16. Braun, Tobias, 2011. "Wie interagieren Banken und Ratingagenturen? Eine ökonomische Analyse des Bewertungsmarktes für strukturierte Finanzprodukte," Discussion Papers 2011-17, Martin Luther University of Halle-Wittenberg, Chair of Economic Ethics.
    17. Francesco Sangiorgi & Chester Spatt, 2017. "Opacity, Credit Rating Shopping, and Bias," Management Science, INFORMS, vol. 63(12), pages 4016-4036, December.
    18. Spiros Bougheas, 2014. "Pooling, tranching, and credit expansion," Oxford Economic Papers, Oxford University Press, vol. 66(2), pages 557-579.
    19. Solomon Y. Deku & Alper Kara & Nodirbek Karimov, 2021. "Do investors value frequent issuers in securitization?," Review of Quantitative Finance and Accounting, Springer, vol. 57(4), pages 1247-1282, November.
    20. Donaldson, Jason Roderick & Piacentino, Giorgia, 2018. "Contracting to compete for flows," Journal of Economic Theory, Elsevier, vol. 173(C), pages 289-319.

    More about this item

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:red:sed019:1105. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Christian Zimmermann (email available below). General contact details of provider: https://edirc.repec.org/data/sedddea.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.