Issuer Credit Quality and the Price of Asset Backed Securities

Abstract

Following the financial market crisis of the past few years, critics and scholars have identified numerous problems related to all parties associated with securitization, including investors, rating agencies, issuers, underwriters, and borrowers. Some of this research focuses on the rating process itself. Adam Ashcraft, Paul Goldsmith-Pinkham, and James Vickery (2009) show that observable credit fundamentals deteriorated relative to ratings between 2005 and 2007. Efraim Benmelech and Jennifer Dlugosz (2009) find that collateralized debt obligations (CDOs) rated by only one rating agency are more likely both to be downgraded and to suffer more severe downgrades than CDOs rated by more than one agency. Joshua Coval, Jakub Jurek, and Erik Stafford (2009a) point out that ratings of CDOs were highly unreliable due to models that were highly sensitive to even small errors in economic projections or losses and that underestimated the correlation of risks across various debt securities. Other research focuses on the conflicts of interest between parties who participate in the underlying processes of originating and bundling loans and collecting payments from delinquent borrowers. Chris Downing, Dwight Jaffee, and Nancy Wallace (2009) find that some residential mortgage backed securities trade in a market for lemons where originators can use private information to determine which mortgage Issuer Credit Quality and the Price of Asset Backed Securities