Security Design and Credit Rating Risk in the CLO Market

Security Design and Credit Rating Risk in the CLO Market

Mike Nawas of Bishopsfield Capital Partners has co-authored a paper that has been published in the Working Paper series of the Dutch Central Bank, De Nederlandsche Bank (DNB). The authors empirically explore the effect of the complexity of a security’s design on hypotheses relating to credit rating risk in the CLO market, before and after the global financial crisis of 2007-2008. Results show that complexity explains the likelihood of rating shopping and rating catering behaviors. The authors show that investors appear to be aware of these credit rating risks, as evidenced by the pricing of CLOs. Further, contrary to common expectations, the authors find that investors do not give any yield benefit to CLOs with a dual rating compared to a single rating. The policy implication is that the regulatory environment could become more effective and efficient if it were to differentiate between complex and non-complex securities.

Working paper No. 643: Security design and credit rating risk in the CLO market