Do credit ratings affect spread and return? A study of structured finance products

Abstract

Although the previous studies investigating the relationship between credit ratings and spread or return in the financial market are normally restricted to noncausal measures, this paper uses structural equation modelling to test the possibility of causal links from ratings to spread and return in the context of structured finance products. Our analyses are split into 2 stages: First, we search for causality between ratings and spread at the issuance stage (primary market) based on a sample comprising all tranches of asset‐backed securities issued in the United States by American and foreign institutions from December 1999 to December 2015. Then, we consider all ABS rating changes from February 2001 to December 2015 to check whether the assumption of causal connection between ratings and return at the trading stage (secondary market) is reasonable. After testing all pertinent combinations among the variables in our database, we find evidence of causality at the issuance stage but very little support to causality at the trading stage. This study contributes to the debate on the regulation of credit rating agencies as our findings suggest that ratings may have an effective influence on decisions made by investors at the time structure finance products are issued. As this effect is very weak when those assets are traded in the secondary market, in principle, regulators should focus their attention on the credit rating agencies' activities regarding the issuance of new structured products.

Are bank risk disclosures informative? Evidence from debt markets

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Community banks' capital requirements and regional housing tenure

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“…Foreign scholars have explored the pricing factors of structured products. In terms of credit rating, (Moreira and Zhao 2018) pointed out that there is a big connection between ABS ratings and their yield spread at issuance in the US market, Credit ratings may affect investors' investment decisions during the issuance stage. Fabozzi and Vink (2012) explored the influencing factors of asset-backed securitization in the European market, indicating that investors will consider other credit factors such as credit enhancement and underlying assets in addition to credit ratings.…”