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Competition in the Credit Rating Industry: Benefits for Investors and Issuers

Listed author(s):
  • Morkoetter, Stefan

    ()

  • Stebler, Roman

    ()

  • Westerfeld, Simone

    ()

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    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 empirical 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 multiple 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.

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    File URL: http://ux-tauri.unisg.ch/RePEc/usg/sfwpfi/WPF-1505.pdf
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    Paper provided by University of St. Gallen, School of Finance in its series Working Papers on Finance with number 1505.

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    Length: 50 pages
    Date of creation: Jan 2015
    Date of revision: Feb 2016
    Handle: RePEc:usg:sfwpfi:2015:05
    Contact details of provider: Phone: +41 71 243 40 11
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    Web page: http://www.unisg.ch/de/universitaet/schools/finance

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    1. Efing, Matthias & Hau, Harald, 2015. "Structured debt ratings: Evidence on conflicts of interest," Journal of Financial Economics, Elsevier, vol. 116(1), pages 46-60.
    2. Walter Krämer & André Güttler, 2008. "On comparing the accuracy of default predictions in the rating industry," Empirical Economics, Springer, vol. 34(2), pages 343-356, March.
    3. 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.
    4. Patrick Bolton & Xavier Freixas & Joel Shapiro, 2012. "The Credit Ratings Game," Journal of Finance, American Finance Association, vol. 67(1), pages 85-112, 02.
    5. Yuliya Demyanyk & Otto Van Hemert, 2011. "Understanding the Subprime Mortgage Crisis," Review of Financial Studies, Society for Financial Studies, vol. 24(6), pages 1848-1880.
    6. Dion Bongaerts & K. J. Martijn Cremers & William N. Goetzmann, 2012. "Tiebreaker: Certification and Multiple Credit Ratings," Journal of Finance, American Finance Association, vol. 67(1), pages 113-152, February.
    7. Stefano Lugo & Annalisa Croce & Robert Faff, 2015. "Herding Behavior and Rating Convergence among Credit Rating Agencies: Evidence from the Subprime Crisis," Review of Finance, European Finance Association, vol. 19(4), pages 1703-1731.
    8. Douglas W. Diamond, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Oxford University Press, vol. 51(3), pages 393-414.
    9. A. Colin Cameron & Pravin K. Trivedi, 2010. "Microeconometrics Using Stata, Revised Edition," Stata Press books, StataCorp LP, number musr, January.
    10. Andrew W. Lo, 2012. "Reading about the Financial Crisis: A Twenty-One-Book Review," Journal of Economic Literature, American Economic Association, vol. 50(1), pages 151-178, March.
    11. Tamás Bartus, 2005. "Estimation of marginal effects using margeff," Stata Journal, StataCorp LP, vol. 5(3), pages 309-329, September.
    12. Holly Janes & Margaret S. Pepe, 2009. "Adjusting for covariate effects on classification accuracy using the covariate-adjusted receiver operating characteristic curve," Biometrika, Biometrika Trust, vol. 96(2), pages 371-382.
    13. Cantor, Richard & Packer, Frank, 1997. "Differences of opinion and selection bias in the credit rating industry," Journal of Banking & Finance, Elsevier, vol. 21(10), pages 1395-1417, October.
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