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Structured finance products are opaque and theirratings are unverifiable. Therefore, a credit rating agency CRA cannotcredibly fully reveal its information about the quality of a rated structuredfinance project. Can reputation discipline the CRA? I introduce incompleteinformation about the CRA’s type: With some probability, it is a truthful typethat always fully reveals its information. The updated probability that theCRA is truthful is its reputation. With only two project types and when the CRA’sreputation is high enough, an informationally-efficient equilibrium, whereinvestors are fully informed, exists. If firms know the true CRA type however,this existence result fails. Moreover, with more than two project types, nomatter how high the CRA’s patience level or its reputation, there is noinformationally-efficient equilibrium. The many project types case is clearlythe relevant case. Therefore, I conclude that the fear to lose reputation isnot enough deterrent in the structured finance market.

KEYWORDS

Credit Rating Agencies, Conflicts of Interest, Reputation

Cite this paper

Elamin, M. 2017 Can Reputation Ensure Efficiency in the Structured Finance Market?. Theoretical Economics Letters, 7, 49-62. doi: 10.4236-tel.2017.71006.





Author: Mahmoud Elamin

Source: http://www.scirp.org/



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