Credit ratings and structured finance

The poor performance of credit ratings on structured finance products has prompted investigation into the role of Credit Rating Agencies (CRAs) in designing and marketing these products. We analyze a two-period reputation model where a CRA both designs and rates securities that are sold to different clienteles: unconstrained investors and investors constrained by minimum quality requirements. When quality requirements for constrained investors are higher, rating inflation increases. Rating inflation decreases if the quality of the asset pool is higher. Securities for both types of investors may have inflated ratings. The motivation for pooling assets derives from tailoring to clienteles and from reputational incentives