Credit-Rating Shopping, Selection and the Equilibrium Structure of Ratings Francesco Sangiorgiy Jonathan Sokobinz June 8, 2009 Chester Spattx
Abstract An important feature of the microstructure of credit ratings is the ability of a security issuer to choose which ratings to purchase. Such choices can re‡ explicit or even implicit ect shopping for favorable credit reviews and induce "selection" e¤ects in the structure of ratings. When there is considerable heterogeneity in views the issuer selects the ratings that are the most positive. Because the correlation among models is least when heterogeneity is greatest, we examine the in‡ uence of the correlation on the extent of ratings shopping and bias. Selectivity highlights the interaction between the decision about whether to rely on unsolicited ratings based upon coarser information and the potential for ratings shopping, illustrating the interaction between di¤erent types of potential con‡ icts of interest in the credit rating process. We use selection to provide an equilibrium interpretation for "notching" (formulaic haircutting of a credit rating agency’ rating) by a rival. We s point to the potential winner’ curse that is implicit when the most favorable rating is s the only rating published, raising the issue of how rating agencies, regulatory authorities and investors interpret solicited ratings. We conclude by presenting theoretical results and numerical solutions to illustrate qualitative aspects of rating shopping. For example, we show that higher cost of obtaining indicative ratings and regulatory mandates to charge fees for obtaining indicative ratings reduce the extent to which these are obtained, increasing the average published ratings. The higher cost of ratings also reduces the likelihood that an unpublished rating is below an existing published one. We wish to thank the participants at the Swedish Institute for Financial Research Conference on “The Changing Nature of Credit Markets: Risks and Opportunities,” the Columbia "Law and Economics of Capital Markets" Workshop, the Carnegie Mellon …nance seminar, the Notre Dame "Securities Market Regulation" Conference and the University of Wisconsin Conference on "Real Estate Finance and Housing" for helpful comments and the Sloan Foundation for …nancial support to some of the authors. The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of the authors and do not necessarily re‡ the views of ect the Commission, the Commissioners, or members of the sta¤. y Stockholm School of Economics z Securities and Exchange Commission x Carnegie Mellon University and National Bureau of Economic Research
Both the …nancial market crisis and the 2006 changes in the statutory framework underlying the role and structure of credit-rating agencies have focused attention upon the microstructure of credit ratings. Indeed, the failures of credit rating agencies during the market crisis had been the subject of Congressional hearings and Securities and Exchange Commission rulemakings, also motivating a number of potential regulatory proposals. Credit ratings are central to a broad array of valuation and regulatory issues in the marketplace. At the heart of the micro aspects of credit ratings of …nancial instruments are “selection e¤ects” that arise at many levels. These occur because of the ability of security issuers to choose which credit ratings to purchase and have published. Such choices by an issuer can re‡ explicit or even implicit ect 1 As a result of “selection,”there is information not shopping for more favorable credit ratings. only in the ratings obtained for an issue, but also statistical information attributable to the absence of ratings from various credit-rating agencies. Interestingly, the shopping for credit ratings and their purchase from speci…c...
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