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Working Paper

Believe Only What You See: Credit Rating Agencies, Structured Finance, and Bonds

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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.
Topics
Financial networks
10.29.2012ISSN 2573-7953 WP 12-22DOI 10.26509/frbc-wp-201222
Keywords credit rating agencies, reputation, infinitely repeated game
JEL Classification Codes G2, D8

Working Papers of the Federal Reserve Bank of Cleveland are preliminary materials circulated to stimulate discussion and critical comment on research in progress. They may not have been subject to the formal editorial review accorded official Federal Reserve Bank of Cleveland publications. The views expressed in this paper are those of the authors and do not represent the views of the Federal Reserve Bank of Cleveland or the Federal Reserve System.

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. https://doi.org/10.26509/frbc-wp-201222