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Did Subjectivity Play a Role in CDO Credit Ratings?




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    • Griffin is at the University of Texas at Austin and Tang is at the University of Hong Kong. We thank the BSI Gamma Foundation, McCombs Research Excellence Fund, Hong Kong RGC Grant #751109, the McCombs School of Business, University of Hong Kong, and HKUST for generous support. We thank an anonymous referee, Associate Editor, and Cam Harvey for detailed and beneficial comments. We also thank Itzhak Ben-David, Efraim Benmelech, Bernie Black, Michael Brandt, Benjamin Bystrom, Eric Chang, Joshua Coval, Prachi Deuskar, David Deutsch, Jerry Dwyer, Erkan Erturk, Mark Grinblatt, Bing Han, Jean Helwege, Burton Hollifield, Philip Jorion, Cathy Kahle, Robert Kuberek, Hayne Leland, Michael Lemmon, Francis Longstaff, Evgeny Lyandres, Peter MacKay, Paul Malatesta, Joseph Mason, Frank Partnoy, Lee Partridge, Neil Pearson, Edward Rice, Michael Roberts, Kimberly Rogers, Ann Rutledge, Tony Sanders, Til Schuermann, Mark Seasholes, Amit Seru, Clemens Sialm, Jonathan Sokobin, Chester Spatt, René Stulz, Wing Suen, Sheridan Titman, Nancy Wallace, Lori Walsh, Ashley Wang, Yintian Wang, Yingzi Zhu, and seminar participants at the 16th Mitsui Finance Symposium at the University of Michigan, 2009 China International Conference in Finance, 2009 Conference on Empirical Legal Studies, 2009 NY Fed/NYU Stern Conference on Financial Intermediation, 2009 SFM Conference at National Sun Yat-Sen University, 2010 American Finance Association meetings, 2010 Atlanta Fed Financial Markets Conference, China-Europe International Business School, 2010 China International Finance Conference, 2010 Financial Intermediation Research Society Meeting, 2010 NBER Credit Rating Sessions, 20th Utah Winter Finance Conference, 4th Annual Conference on the Asia-Pacific Markets, University of Arizona, the First Shanghai Winter Finance Conference, Fudan-UNSW Joint Workshop, Hebrew University, HKUST, City University of Hong Kong, Hong Kong Baptist University, the Hong Kong Monetary Authority, the Securities and Exchange Commission, Shanghai Jiaotong University, Thammasat Business School, University of California at Irvine, University of Hawaii, University of Notre Dame Conference on the Financial Crisis, University of Texas at Austin, University of Texas at Dallas, and University of Washington for helpful discussions and Rolando Campos, Ying Deng, Garrett Fair, Kelvin Law, Dan Luo, Danny Marts, Baolian Wang, Sarah Wang, Miao Zhang, and especially Jordan Nickerson for excellent research assistance.


Analyzing 916 collateralized debt obligations (CDOs), we find that a top credit rating agency frequently made positive adjustments beyond its main model that amounted to increasingly larger AAA tranche sizes. These adjustments are difficult to explain by likely determinants, but exhibit a clear pattern: CDOs with smaller model-implied AAA sizes receive larger adjustments. CDOs with larger adjustments experience more severe subsequent downgrading. Additionally, prior to April 2007, 91.2% of AAA-rated CDOs only comply with the credit rating agency's own AA default rate standard. Accounting for adjustments and the criterion deviation indicates that on average AAA tranches were structured to BBB support levels.