bond ratings

Matt Levine mentions a front-page Wall Street Journal article in today's newsletter, and notes, interestingly,

Moody’s Corp., for instance, gave lower grades to some tranches of commercial mortgage-backed securities than its competitors did, with the result that “by 2015, issuers ‘essentially stopped soliciting our ratings’ on those slices.” And investors priced those tranches accordingly:

Investors demanded higher yields on triple-B portions of deals without Moody’s ratings than on triple-B slices that included Moody’s during 2011 to 2014, according to a Journal analysis of Commercial Mortgage Alert data. The difference was about three-tenths of a percentage point more, on average, than benchmark triple-B rated CMBS—which means it was costlier to borrow than comparably rated debt.

So this looks like one more level of rationality than in what I perceive to be the conventional wisdom: in particular, the issuers do have an incentive to solicit more credible, less lenient ratings, but they don't realize (or act on) them.[1]

The rational equilibrium story you'd like to tell, provided you have a degree from the University of Chicago, is that an issuer would pay for a credible bond rating because bond buyers are risk-averse and will, on average, underpay for a bond that would be rated (say) BBB+ if it is instead unrated because they don't know that it should be rated BBB+.  Because I'm in recent possession of an "ambiguity" hammer, I see an "ambiguity" nail here; "BBB+" is itself essentially a probability of default, and while one can construct purely Bayesian models with risk-averse agents in which credibly revealing additional information is of positive value to sellers, I look at this and wonder whether ambiguity aversion, in which buyers don't know the right probability and are more willing to take on quantified than unquantified risks, can play an additional role.

---

[1] There's some level on which "one more level of rationality than the conventional wisdom" makes a lot of sense; this suggests as a rule of thumb that you should try to be two levels more rational than the conventional wisdom, provided you have a good idea what that is.