Believe Only What You See: Credit Rating Agencies, Structured Finance, and Bonds
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.
JEL Codes: G2, D8.
Key words: Credit rating agencies, reputation, infinitely repeated game.
Suggested citation: Elamin, Mahmoud, 2012. "Believe Only What You See: Credit Rating Agencies, Structured Finance, and Bonds," Federal Reserve Bank of Cleveland, Working Paper no. 12-22.