Ratings Arbitrage and Structured Products
Abstract: This paper examines the criteria used by credit rating agencies when they rate structured products. We assume that some investors use credit ratings as a basis for valuing products. This leads to a necessary condition for a credit ratings criterion to be arbitrage-free. We find that the criterion used by S&P and Fitch does not satisfy the condition and explain that this criterion could have misled investors when subprime mortgages were being securitized.
Keywords: Credit rating, Arbitrage, Structured Products, Crisis, Subprime.
Published in: Journal of Derivatives, Vol. 20, No. 1, (Fall 2012), pp. 80-86.