Does the Market Understand Rating Shopping? Predicting MBS Losses with Initial Yields

Jie (Jack) He, Jun (Q. J.) Qian and Philip E. Strahan

The Review of Financial Studies, 2016, vol. 29, issue 2, 457-485

Abstract: We study rating shopping on the MBS market. Outside of AAA, losses are higher on single-rated tranches than on multi-rated ones, and yields predict future losses for single-rated tranches, but not for multi-rated ones. Conversely, ratings have less explanatory power for single-rated tranches. These results suggest that single-rated tranches have been "shopped," whereby pessimistic ratings never reach the market. For AAA-rated MBS, by contrast, 93% receive two or three such ratings, and those ratings agree 97% of the time. This ratings convergence suggests that agencies "cater" to investors, who cannot purchase a tranche unless it has multiple AAA ratings. Received January 22, 2014; accepted October 21, 2015 by Editor Andrew Karolyi.

Date: 2016
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