Credit Rating Reversals in Securitized Products and Corporate Bonds

Abstract

The excessively high credit ratings given to securitized products like CDOs and MBS are among the many purported causes of the 2008 financial crisis. The proportion of securitized products given AA to AAA ratings was far higher than the amount given to corporate bonds. Due to the sheer degree of upward ratings bias and the sensitivity of these products to changes in collateral assets, these assets proved volatile and prone to “rating reversals”. We find that these reversals (sudden changes in rating trend within a 12-month period) act primarily to re-upgrade speculative-grade or recently downgraded bonds. This tendency was found in both pre-crisis and post-crisis time periods, and intensified after 2008. It occurs independently of and counteracts the overall drop in securitized products’ credit ratings. This increased rating volatility, as evidenced by the frequency of these reversals despite alterations to rating distribution after 2007, suggests that credit ratings are a poor metric of risk for these products.