Do Multiple Credit Ratings Signal Complexity?

Do Multiple Credit Ratings Signal Complexity?

Evidence from the European Triple-A Structured Finance Securities

In much of the current research on market practices with respect to the use of credit ratings, the rating shopping hypothesis and the information production hypothesis feature prominently. Both of these hypotheses predict an inverse relationship between the number of ratings and a security’s funding cost; that is, more ratings will reduce funding costs and, conversely, fewer ratings will increase funding costs.

Our study finds precisely the opposite to have been the case for the mainstay of the structured finance securities market in Europe prior to 2007, namely the triple-A tranches of European residential mortgage-backed securities.

Our findings suggest that structured finance markets may behave differently than what would be predicted by two hypotheses traditionally used to explain the number of ratings and funding costs: the rating shopping and information production hypotheses. Obtaining multiple credit ratings may be a signal for complexity, for which investors demand a risk premium.

Edhec Working Paper 28-04-2015 Do multiple credit ratings signal complexity?

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