DOES THE MARKET UNDERSTAND RATING SHOPPING?

PREDICTING MBS LOSSES WITH INITIAL YIELDS†

Jie (Jack) He Jun ‘QJ’ Qian Philip E. Strahan

University of Georgia Boston College Boston College & NBER
jiehe@uga.edu qianju@bc.edu strahan@bc.edu

Current version: March 2013

Preliminary, comments welcome

Abstract

We study the effects of rating shopping on the market for MBS. Outside of AAA, realized losses
were much higher on single-rated tranches than on those with multiple ratings, and yields predict
future losses for single-rated tranches but not for multi-rated ones. These results suggest that single-
rated tranches have been ‘shopped,’ whereby pessimistic ratings never reach the market. In the
AAA market, by contrast, most tranches receive two or three ratings and those ratings almost
always agree. The convergence in ratings suggests that rating agencies may have ‘catered’ to
investors, who could not purchase a tranche unless it has multiple AAA ratings.

JEL Classifications: G21, G24, G28, G1, L1.

Keywords: Credit ratings, mortgage-backed securities, shopping, loss, yield.

                                                            
†
We appreciate helpful comments from John Griffin. We thank Lei Kong, Ali Ebrahim Nejad, Lin Shen, Yingzhen Li,
and Chenying Zhang for excellent research assistance and Boston College and University of Georgia for financial
support. The authors are responsible for all the remaining errors.
I. INTRODUCTION

There is growing evidence revealing problems in the practice of credit rating agencies,

especially in the structured finance markets including mortgage-backed securities (MBS). The root

of the problems stems from the fact that agencies face a potential conflict of interest: instead of

being rewarded by “consumers” for high-quality ratings, agencies are paid by issuers. Therefore,

critics stipulate that agencies may be under pressure to grant inflated ratings to compete for business

despite possible loss of reputation (e.g., Bolton, Freixas, and Shapiro, 2012; Bar-Isaac and Shapiro,

2010). Moreover, regulations contingent on ratings may further distort the incentives of both

issuers and agencies: holding highly rated MBS securities lowers the burden of capital requirements

for financial institutions (e.g., Acharya and Richardson, 2009; Acharya, Schnabl, and Suarez, 2011),

while other institutional investors (e.g., pension funds) are constrained to hold ‘safe’ fixed income

assets as certified by multiple AAA ratings.

The perverse incentives of issuers and rating agencies can affect the quality of ratings

through the process of ‘rating shopping,’ whereby issuers only purchase and report the most

favorable rating(s) after receiving preliminary opinions from multiple agencies(e.g., Mathis,

McAndrews, and Rochet, 2009; Skreta and Veldkamp, 2009; Opp, Opp, and Harris, 2011). Since

issuers are not required to disclose their preliminary contacts with rating agencies, shopping tends to

be hidden from view (e.g., Sangiorgi and Spatt, 2010; Fulghieri, Strobl, and Xia, 2012); yet, it

influences the distribution and information content of ratings that are revealed to investors (and thus

observable in our dataset). Shoppers tend to censor out pessimistic ratings, thus reducing the

number of ratings observed empirically and, at the same time, reducing the likelihood of observed

ratings disagreements. Ratings convergence can also result from the threat of shopping, and may be

particularly pronounced in the AAA segment, where investors constrained by regulations or

contractual terms cannot purchase a tranche unless it has at least two ratings. Beyond the number of
1
ratings, earlier research (He, Qian, and Strahan, 2012) suggests that market yields were higher on

MBS sold by large issuers, suggesting the investors ‘priced’ the risk that large issuers used their

bargaining power to receive inflated ratings.

In this paper, we test whether the market goes beyond the credit rating in pricing risks by

linking cumulative losses on tranches through 2012 to initial yields on those tranches, conditional

on the rating (and other observables). If the market rationally suspects poor-quality ratings – either

because deals have been sold by large issuers with substantial bargaining power, or because

investors observe just one rating and thus infer that shopping has occurred – then initial yields ought

to predict ex post performance. In contrast, if investors trust ratings at issuance, then yields ought

to have little incremental power to forecast future outcomes. This idea forms the basis for our

empirical tests.

We match a large sample of privately issued (non GSEs) MBS tranches sold between 2000

and 2006 with information on initial yield (at issuance), rating history (from Moody’s, S&P and

Fitch) and cumulative losses (percentage of principal balance write offs due to default through June

2012). We obtain data on the characteristics of the tranches, including principal amount, weighted

average life, geographical distribution of the underlying mortgages, loan to value (LTV) ratio and

weighted average credit score of the collateral. We also collect information on the issuers, such as

issuer size (the issuing institutions’ one-year lagged annual market share), type (whether it is a

depository institution) and rating at the issuance date.

Not surprisingly, default rates rise dramatically for tranches sold during market boom years

(2004-2006) as compared to earlier years (2000-2003). Tranches retaining the highest AAA rating

(or equivalent) typically have two or three such ratings. These facts suggest that in the AAA

market, rather than dropping pessimistic ratings, the threat of rating shopping leads to convergence.

The AAA tranches also have very low default rates: tranches sold in 2006 (2005) have an average

2
default rate of 5.3% (1%) while in all other years the average default rate is 0. Outside of AAA,

however, a much higher percentage of tranches receive just one rating (nearly 1/3), and the default

rates of the single-rated tranches exceed those with two- or three-ratings. For example, conditional

on ratings we find default rate are 17.2% higher for one-rated tranches compared to similarly-rated

tranches with two or three ratings. Thus, in the non-AAA market, shopping seems to lead issuers to

drop the more pessimistic ratings, perhaps because many of the investors are less likely to require

multiple ratings for regulatory or contractual compliance.

To test for the information content in yields, we regress ex post default rates on the log of

yield spread at issuance on the pooled sample of all cohorts (2000-2006), comparing the

explanatory power of yields based on issuer size and across tranches with one-, two- and three-

ratings. Initial yields strongly predict future losses for tranches sold by large issuers during the

boom years, and for those with a single rating. These results indicate that when investors are

concerned about the integrity of the ratings process – when issuers are large, or when investors infer

ratings shopping – pricing embeds information about risk that goes well beyond the credit rating. In

contrast, initial yields have no incremental explanatory power over ratings when tranches have

multiple ratings or are sold by small issuers.

In our second set of results, we then split the sample into the AAA and non-AAA segments.

Shopping’s effects are clear in the non-AAA segment: higher initial yield spreads predict greater ex

post losses for one-rated tranches, and this relation becomes stronger during the boom period.

These results support the hypothesis that tranches with only one reported rating have been shopped,

with the more pessimistic ratings never reaching the market. As noted above, however, within the

AAA segment almost all tranches have at least two ratings (93%). Unlike the non-AAA market,

yields predict future losses only when there are exactly two ratings. This pattern suggests that

ratings agencies have catered to investors in the AAA market, who could not purchase a tranche

3
unless it has at least two AAA ratings. These results are also consistent with the findings of Griffin

and Tang (2013), who find that one of the rating agencies adjust the ratings on a sample of CDOs

from their quantitative models to ‘catch up’ with more favorable ratings from another competing

agency.

In our final set of results, we directly compare the information content in ratings themselves

with that of initial yields. To do so, we map the discrete ratings at issuance into the Expected

Default Frequency (EDF), equal to the average default frequencies across each rating category

provided by S&P’s Global Structured Finance five-year cumulative default rates ending in

December 1999. We find that EDF’s ability to forecast future losses declines with issuer size,

whereas the power of yields increases with issuer size. Together these results suggest that the

market prices become more important at the margin when ratings themselves are less informative

due to perceived compromises in the integrity of the bargaining between large issuers and the

ratings agencies. The contrast between the effects of yield and EDF in predicting losses supports

the findings of He et al. (2012). They find the market ‘prices’ the risk of tranches sold by large

issuers by demanding higher initial yields, since ratings agencies may have granted more inflated

ratings to these tranches.

Our paper extends the recent literature on how incentive and regulatory problems affect the

quality of ratings.1 While Griffin and Tang (2012) and He et al. (2012) examine how incentive

problems of rating agencies affect the subordination and pricing of structured finance products, we

link ex post losses of MBS to ex ante pricing of these securities. Adelino (2009) also finds that

initial yield spreads predict ex post performance of MBS tranches, but he does not examine how this

predictability is linked to the market’s assessment of rating shopping based on the number of

                                                            
1
For example, Jiang et al. (2012) find switching from investor-pay to issuer-pay model leads to ratings inflation in the
corporate bond markets, while Stanton and Wallace (2012) find regulation capital arbitrage leads to more inflated
ratings in the commercial MBS market.
4
reported ratings and rating categories. Benmelech and Dlugosz (2009) also find that CDOs

(including MBS) with one rating are more likely to be downgraded and link this finding to

shopping, while Griffin and Tang (2013) find evidence supporting catering by rating agencies with

a sample of CDOs and two rating agencies’ internal models. Our results in the AAA segment of the

MBS market are consistent with the findings of Griffin and Tang, but our results on the differences

between single-rated tranches and multi-rated tranches (outside AAA) support the rating shopping

hypothesis and extend the work of Benmelech and Dlugosz.

The rest of the paper is organized as follows. In Section II we introduce our data on MBS

securities and our empirical methods. In Section III we present results from our empirical tests and

some discussions. We conclude in Section IV.

II. DATA AND METHODS

Our MBS sample is obtained by matching data from the Securities Data Corporation (SDC)

and Bloomberg. SDC provides information on issuance date, asset/collateral types (mortgage, credit

card, auto loans, bonds, etc), the number of tranches, as well as information on the issuers and

bookrunners on a large sample of tranches of privately-issued MBS deals. For other deal, tranche,

and collateral characteristics, including cumulative losses (default rates), initial ratings, principal

amount, coupon type and rate, deal name and type, maturity (weighted average life), the originator

and servicer identities, the geographic distribution of collateral, as well as the loan to value (LTV)

ratio and weighted average credit score of the collateral, we manually collect data from Bloomberg.

Our sample includes MBS deals originated and issued in 2000 through 2006, and we follow

the cumulative losses (percentages of balance write offs due to default) of these deals/tranches

through June of 2012. We obtain ratings from the largest three credit rating agencies, Moody’s,

S&P, and Fitch, and our final sample includes MBS tranches that are rated by at least one of the

5
agencies at issuance.

II.1 Empirical Models

We estimate OLS models relating initial yield spread and its interactions with various issuer

and market characteristics to Default Rate, a tranche’s cumulative loss rate from the issuance date to

June 2012. The key explanatory variables are the natural logarithm of the initial yield spread (Log

Yield) and its interaction with Hot, a dummy indicating that a deal is issued in the hot MBS market

from 2004 to 2006, with Issuer Share, the lagged MBS market share of the issuer based on the

number of deals originated in the previous year, and with One Rating, a dummy indicating that a

tranche is rated by only one credit rating agency at issuance. To summarize analytically:

Default Ratei,j,t = β1Log Yieldi,j,t + β2Log Yieldi,j,t × Hott + β3Log Yieldi,j,t × Issuer Sharek,t-1 + β4Log
Yieldi,j,t × One Ratingi,j,t + Initial Rating × Issuance Year fixed effects + Deal , Tranche, Collateral,
and Issuer controls +ei,j,t (1)

The data vary by year (t), issuer (k), deal (i) and tranche (j). In all of our tests, we include initial

rating (averaged across all ratings received by a tranche) × cohort (issuance) year fixed effects,

separate intercepts for coupon types (such as floating, fixed, etc.) and deal types given by

Bloomberg (such as “ABS Home”, “CMBS”, “Private CMO Float”, etc.), and we cluster standard

errors by issuers. Note that by including the Initial Rating × Issuance Year fixed effects, we absorb

the direct effect of Hot, which has only time variation but no cross-sectional variation; hence, we

only report its interaction with issuer size.

II.2 Variable Construction and Summary Statistics

Dependent Variable and Key Explanatory Variable

Table I, Panel A reports summary statistics for the overall sample. We have two sets of

variables to measure ex ante pricing (yield spread) and ex post performance (default rate). The mean

6
default rate for the MBS tranches in our sample is 20% while the median is only 0%, since a large

fraction of the tranches are AAA-rated at issuance and have zero losses, whereas a small fraction of

the tranches (around 10%) have lost all their balances (i.e., the default rate is 100%).

Our key explanatory variable, Initial Yield Spread, equals the yield spread of a tranche at

issuance. For a tranche with a floating coupon rate, yield spread is defined as the fixed mark-up, in

basis points (bps), over the reference rate specified at issuance (e.g. the 1-month LIBOR rate). For a

tranche with a fixed or variable coupon rate, yield spread is defined as the difference between the

initial coupon rate and the yield on a Treasury security whose maturity is closest to the tranche’s

weighted-average life. The mean yield spread is 125 bps over the whole sample.

Issuer Characteristics

Issuer Share equals the number of MBS deals sold by an issuer over the total number of

deals sold by all issuers in the previous year (using alternative measures of issuer market share

based on the principal amounts yields very similar results). We denote market boom years through a

dummy variable, Hot, which equals one if a deal is issued between 2004 and 2006, and zero

otherwise. We are interested in testing whether the predictability of initial yield spreads for future

losses changes when the issuers have more market power or when markets boom, so we introduce

the interaction variables, Log Yield × Issuer Share and Log Yield × Hot.

Since the value of implicit recourse to investors may increase with issuer reputation, we

control for issuer rating, equal to the numerical score for the rating of the issuer at the issuance date

(AAA = 1; AA+ =1.67, AA = 2, AA- = 2.33, and so on); the mean issuer rating is A. In our tests we

also differentiate issuer types, and include an indicator equal to one for banks and thrifts, who face

tighter regulatory capital requirements than other MBS issuers such as finance companies (e.g.

GMAC) or investment banks (e.g. Bear Stearns, Lehman, etc.). If regulatory arbitrage encourages

the regulated banks to securitize their assets more aggressively, then there may be differences in
7
deal structure, collateral quality, pricing, and ex-post loss rates. We also construct Same Originator

Servicer, an indicator set to 1 if the originator and the servicer of the tranche are the same firm and

0 otherwise. (Same Originator Servicer is also only available for a subset of our data; hence we

estimate our models with an additional indicator, Missing Originator Servicer, equal to one if the

information on originator or servicer is not available.)

Relationship is an indicator set to 1 if a tranche is rated by at least one “relationship” agency

to the issuer at issuance. For a given issuer-agency pair, the agency is defined as the “relationship”

agency for the issuer if in the previous year: (1) this agency rated at least 70% of all the deal

amounts issued by this issuer and this agency is the “top” agency, i.e., it rated this issuer’s deals

more than the other two agencies; or (2) this agency rated at least 60% of all the deals issued by this

issuer and it is the “middle” agency (i.e., the second largest agency for this issuer in the previous

year) and that the difference between the “middle” and “top” agencies is not larger than 10%; or (3)

this agency rated at least 60% of all the deal amounts issued by this issuer and this agency is the

“bottom” agency (i.e., the agency with the least market share for this issuer in the previous year)

and that the difference between the “middle” and “bottom” agencies is not larger than 10%. For

example, if Moody's rated 85% of the deals sold by an issuer, S&P rated 75%, and Fitch rated 58%,

then only Moody's and S&P are defined as this particular issuer’s “relationship agency” in that year.

But if Fitch's share is 65% or higher, then it is also considered a “relationship agency” even if it has

the smallest market share. Relationship is set to one if the tranche is rated by at least one

“relationship” agency. That is why even if a tranche is rated by all three agencies in a given year, it

may still have no relationship agency because none of the agencies rated enough deals (60% or

70%) for this issuer in the previous year.

Deal Structure

Table I, Panel A also reports summary statistics for Initial Rating, which equals a numerical
8
score based on the average of the ratings a tranche received at issuance. In the regressions, we

control for the interactions of a full set of dummies based on Initial Rating and issuance (cohort)

years. This non-parametric strategy allows us to avoid imposing any functional relationship between

the ratings and ex-post losses. As our main measure of deal structure, we add the Level of

Subordination (Panel A) for each tranche, defined as the dollar-weighted fraction of tranches in the

same deal that have a rating the same as or better than the given tranche. For example, for a

hypothetical $100 million deal with $80 million in the AAA tranche, $10 million in the BBB

tranche, and another $10 million in the B tranche, the Level of Subordination would equal 80% for

AAA, 90% for BBB and 100% for B. This variable increases as the amount of protection for a

given tranche by lower rated tranches decreases.

Opp, Opp, and Harris (2011) show theoretically and Furfine (2011) empirically that more

complex deals may lead to greater ratings inflation. To control for this mechanism, we add the

variable Deal Complexity, which equals the number of tranches within a deal divided by the total

principal amount of the deal. In addition, we control in some models for the number of ratings a

tranche receives at issuance, using an indicator equal to 1 for deals with one rating and another

equal to 1 for deals with two ratings. The process of shopping implies that deals with just one or

two ratings are more likely to have been shopped than those with three. Some deals with two or

three ratings may also have been shopped, forcing the ratings to converge, but we do observe some

tranches with multiple ratings where the agencies disagree. We control for this effect by adding

another variable, Rating Disagreement, an indicator for deals with more than one rating in which

the ratings differ.

Collateral

We include a number of control variables to capture characteristics of the underlying

collateral. From Panel A, Principal amount equals the dollar value of the tranche; its distribution is
9
highly skewed, with the mean $57 million and median only $15 million. Weighted-average life,

equal to the expected timing of payments of principal of a tranche, is also skewed with the mean 5.6

years.2 Fraction of collateral in troubled states equals the fraction of collateral originated in

Arizona, California, Florida, and Nevada. It measures the degree of exposure to areas that

experienced the highest house price rise leading up to the crisis followed by the largest drop during

the crisis.3 Herfindahl Index of Collateral measures geographical concentration of the collateral

pool, equal to the sum of the squared shares of the collateral within a deal across each of the top five

states (with the largest amount of mortgages), with the aggregation of all the other states as the sixth

category. It controls, admittedly crudely, for the degree of correlation across loans within a given

pool. In our regressions, we also control for the Loan to Value (LTV) Ratio and the Weighted

Average Credit Score of the underlying collateral for a given tranche at issuance. Table I, Panel A

provides summary statistics for variables used in our regressions.

Sample Description

Panel B of Table I sorts the tranches into cohorts based on issuance year and the number of

initial ratings. The mean default rate is much greater during the housing market boom of 2004-2006,

regardless of how many initial ratings a tranche receives. Except for years 2000 and 2001, tranches

with only one initial rating perform much worse on average than those with two or three ratings,

and the gap becomes much wider during the hot years. Hence, in our regressions below, we

compare the loss predictability of yield spread for tranches with different number of initial ratings

across this boom period vs. the earlier sample period (2000-2003).

                                                            
2
Note that this is not the same as duration that measures the weighted-average time to maturity based on the relative
present values of cash flows as weights (see, e.g., Ch. 27 of Saunders and Cornett, 2008, for more details).
3
We realize that the importance of this variable may be obvious only in hindsight, although some analysts were
concerned about overheated regional markets in real time; nevertheless, all of our key findings are robust to the
exclusion of this variable from our models.
10
 Panel C and Panel D of Table I further reveal that the above pattern is mainly driven by non-

AAA-rated tranches. From Panel C, AAA-rated tranches have very low default rates on average,

and the average defaults do not differ much by the number of initial ratings, except for year 2006. In

contrast, non-AAA-rated tranches, as shown in Panel D, have much higher average default rates.

While one-rated non-AAA tranches issued in 2000 and 2001 perform better than two- or three-rated

non-AAA tranches issued in the same period, this pattern flips when the housing market becomes

hotter, especially in 2004 and 2005. In addition, comparing Panels C and D shows that while one-

rated tranches only constitute a small proportion of the AAA market across all years, they carry

more weight in the non-AAA market. For example, in 2005, one-rated tranches comprise only 9.1%

of the AAA market [= 870 / (870 + 7,348 + 1,331)] but 31.4% of the non-AAA market [= 3,025 /

(3,025 + 4,679 + 1,944)], and this pattern holds true for most other years in our sample. Together,

these simple statistics suggest larger ex-post losses for tranches issued in the market booming

period and those with only one initial rating, and show that such differences in credit quality mainly

exists in the non-AAA market.

Table II reports further rating and default characteristics sorted by initial rating categories

(based on the best rating a tranche receives at issuance) and the number of initial ratings. Panel A

analyzes the full sample, and shows that the majority of the AAA tranches (around 93% of them)

are rated by two or three rating agencies whereas non-AAA tranches have considerable higher

fractions of one-rated tranches. In particular, more than 60% of the tranches with initial ratings of

BB and worse are rated by only one rating agency at issuance, suggesting that lower-rated tranches

outside the AAA market are more likely to have been shopped (i.e., having their inferior ratings

hidden from the market).

The second column in the table, based only on those tranches with two or three ratings,

shows an inverted-U pattern of the disagreement level with regard to initial rating categories. Both

11
the AAA tranches and tranches with “BB and worse” have a very low level of rating disagreement

(less than 3% of these tranches have different initial ratings from different agencies), which is partly

due to the fact that these tranches, with either very high or low credit quality, are easier for the

agencies to assign ratings. Tranches with intermediate credit quality and thus middle initial ratings,

on the other hand, are harder to evaluate and require more discretion from the agencies, which leads

to a much higher rating disagreement level. The evidence here for AAA-rated tranches is also

consistent with the findings of Griffin and Tang (2013), who argue that “ratings catering” leads to

the low level of disagreement for AAA-rated tranches in their sample of collateralized debt

obligations (CDOs).

The last three columns in Table II, Panel A report the average default rates for tranches with

one, two, and three initial ratings, respectively. While the average default rates for one-rated AAA

tranches are much smaller than two- or three-rated AAA tranches, this pattern is less clear outside

the AAA market. In fact, as we go down the rating notches, the average default rates for one-rated

tranches tend to match up with the loss rates for two- or three-rated tranches. This pattern is

stronger in Panel B of Table II, which only focuses on the market booming period from 2004 to

2006. For tranches whose best initial ratings are “BBB” or worse, their average default rates are

higher if these tranches only have one initial rating than if they have two or three ratings. These

univariate comparisons suggest that while one-rated tranches on average perform better than

multiple-rated tranches for higher initial rating categories (such as the AAA one), potentially

consistent with “ratings catering”, one-rated tranches tend to perform worse than multiple-rated

ones for lower initial rating categories, indicating a much severer “shopping” effect in the non-AAA

market, where inferior initial ratings have been dropped by the issuers.

Fig. 1, Panel A and B make the above comparisons more lucid. Panel C of Fig. 1 examines

tranches with identical (non-disagreeing) initial ratings during the hot market period, where

12
potential ratings shopping incentives are the strongest. It is very clear that one-rated tranches have a

much higher average default rate than multiple-rated tranches in the non-AAA market, suggesting

that lower initial ratings different from the highest rating have been dropped and hidden from the

market.

Overall, these simple summary statistics indicate that the credit quality of tranches issued in

the market booming period and those with only one rating is lower than those issued during 2000-

2003 and those with multiple ratings, especially in the non-AAA market. To the extent that the

number of initial ratings a tranche receives signals potential ratings shopping behavior, we next

examine whether the market has the ability to detect such adverse incentives and perform more due

diligence when the observed (shopped) ratings fail to adequately predict losses.

III. REGRESSIONS RESULTS

Tables III-VI report the estimates of Equation (1) for various subsamples of data. Since most

of the securities are priced and sold at par, initial yield spreads gauge the market’s assessment of ex

ante credit quality (i.e., risk). Ideally credit ratings should act as a sufficient statistic for risk (absent

agency problems), so that initial yield spreads should not predict future losses once we adequately

control for the ratings. However, if the ratings are inaccurate (due to various reasons including

agency problems) and the market produces its own credit quality information beyond that contained

in the ratings, then the initial yield spread will have predictive power for future (ex-post) losses.

In Table III, we regress the ex-post default rates on the natural logarithm of initial yield

spread and other characteristics of the tranches, deals, the issuer, and the market, after controlling

for the full set of interactions between initial average rating categories and the cohort (issuance)

year. Table IV performs similar regressions on subsamples split by the number of initial ratings.

Both tables look at the full sample as well as the hot period (2004 to 2006) sample. Table V

13
examines the hot-period subsample by looking at the AAA and non-AAA tranches separately. Table

VI improves on Equation (1) by adding one more variable: the interaction of issuer market share

and the Expected Default Frequency (EDF), or the average of each rating’s EDFs provided by the

S&P Global Structured Finance 5-year Cumulative Default Rates ending in Dec. 1999 (Appendix

Table 3).

In doing so, we attempt to answer the following questions. First, does the market price

(initial yield spread) predict future losses of MBS tranches beyond what ratings do? Second, if the

market price does contain important credit quality information beyond what the ratings imply, when

is its predictive power stronger? In particular, does the market understand ratings shopping and

perform more due diligence to make initial yield spread more predictive of future losses when

certain tranches have been shopped? Further, is initial yield spread more useful in predicting default

rates of MBS deals sold in the market booming period when incentive problems are much worse?

Lastly, since He et al. (2012) show that MBS tranches sold by larger issuers could suffer more from

conflicts of interest on the part of rating agencies, we attempt to compare the relative predictive

power of market price (initial yield spread) and EDFs of initial ratings for deals sold by large vs.

small issuers.

Table III tests whether initial yield spreads predict MBS default rates after controlling for

the full set of interactions between indicators for each unique value of the average rating and cohort

year, i.e., the differential impact of each rating category in each cohort year. We also include

dummy variables for coupon types (such as floating, fixed, etc.) and deal types given by Bloomberg

(such as “ABS Home”, “CMBS”, “private CMO Float”, etc.), which are not reported. We cluster

the standard errors of the coefficients by issuers.

Panel A reports results using the full sample. We find that tranches with only one rating

have much higher default rates than multiple-rated tranches, conditional on ratings. The coefficient

14
before One Rating in column (1) suggests that conditional on ratings and other observables, the

average default rate for a tranche with only one initial rating is 3.44 percentage points higher than a

similar tranche with two or three initial ratings. Given that the average default rate in our sample is

20 percent, this represents a 17.2% difference, which is economically large.

While initial yield spread itself does not significantly predict MBS default rates (its

coefficient is positive but not significant), its predictive power becomes significantly stronger

during hot years. Note that higher initial yield spreads indicate that MBS investors perceive a

greater amount of credit risk. Hence, a significantly positive coefficient before Log Yield * Hot

means the market is better able to correctly infer about future losses during the booming period. In

terms of economic significance, the coefficient before Log Yield * Hot from column (2) indicates

that for tranches issued in the market booming period, doubling the initial yield spread will be

associated with a default rate that is 0.88 percentage points higher (Log (2) * 0.0127 *100= 0.88),

whereas for tranches issued during 2000-2003, such big differences in initial yield spreads will not

be associated with significantly different default rates.

The coefficient of Log Yield * Issuer Share is not statistically significant, indicating that

over the whole sample period, the market does not possess more credit quality relevant information

than rating agencies for MBS deals sold by large vs. small issuers. The coefficient of Log Yield *

One Rating is, however, significantly positive at 1%, which means that the market produces more

credit quality related information than what the ratings contain for tranches with only one initial

rating than those with multiple ratings. This result suggests that MBS investors are aware of the

potential ratings shopping problem plaguing one-rated tranches. The economic magnitude of the

effect is also large: the coefficient before Log Yield * One Rating from column (4) indicates that for

tranches with only one initial rating, doubling the initial yield spread will be associated with a

default rate that is 1.48 percentage points higher (Log (2) * (0.0358-0.0144) *100= 1.48). In

15
contrast, for tranches with two or three ratings, doubling the initial yield spread will be associated

with a default rate that is 1 percentage points lower (Log (2) * (-0.0144) *100= -1).

Other control variables relate to future default rates as expected. Tranche size (the log of

principal amount) is negatively associated with future losses, indicating that larger tranches are in

general safer. Tranches with a greater fraction of their underlying mortgages originated from

‘troubled’ states (AZ, CA, FL, and NV) have significantly higher future losses. Interestingly, better-

diversified tranches, as measured by a lower cross-state HHI, have higher cumulative losses,

consistent with the idea that such tranches act like “economic catastrophe bonds” with a high

exposure to systematic risk. Issuer rating has a significantly positive effect on default rates,

suggesting that declines in an issuer’s credit standing (i.e., a higher “rating score” in our

regressions) decrease its value of implicit recourse (Gorton and Souleles, 2010). Consistent with the

univariate results in Table II, tranches with only one initial rating perform much worse than those

with three ratings (the omitted category) while there is no statistically significant difference between

two-rated and three-rated tranches. Further, tranches with disagreeing initial ratings tend to have

higher future default rates, indicating that risky tranches may be harder to evaluate and induce more

diverse opinions from the rating agencies. Deal complexity, measured as the number of tranches in

a deal per dollar of its total principal amount, is negatively related to future losses, which is mainly

due to the high correlation of this variable with other controls. Lastly, the loan to value (LTV) ratio

of the underlying collateral supporting a tranche is positively related to its future losses, which is

intuitive.

Panel B of Table III reports the same set of models but analyzes tranches issued only during

the market booming period. Since Hot equals one for all the observations in this subsample, we

drop the variable Log Yield * Hot. Interestingly, the variable Log Yield * Issuer Share now becomes

significantly positive, indicating that the market recognizes rating agencies’ inherent conflicts of

16
interest for MBS deals sold by larger issuers during the hot market period. Consequently, the MBS

investors exert more effort in collecting information about deal quality and risk, which makes the

predictive power of initial yield spread much greater for deals sold by larger issuers such as

Countrywide and Lehman Brothers. In terms of economic magnitude, the coefficient before Log

Yield * Issuer Share from column (2) indicates that for tranches sold by a large issuer (with 10%

market share), doubling the initial yield spread will be associated with a default rate that is 1.37

percentage points higher (Log (2) * 10%* 0.1975 *100= 1.37), whereas for tranches sold by a small

issuer (with market share close to zero), such differences in initial yield spreads will not be

associated with significantly different default rates.

Moreover, the coefficient before Log Yield * One Rating from column (3) not only is

significant at the 1%, but also has a magnitude almost twice as large as that in Column (4) of Panel

A, Table III, indicating that initial yield spread is even more powerful in predicting future losses for

one-rated tranches during the market booming period when the perverse incentive problems for

rating agencies are the greatest. This result is also consistent with our univariate findings in Table II

that one-rated tranches have larger default rates than multiple-rated tranches during the hot period.

Table IV repeats the analysis in Table III after splitting the sample based on the number of

initial ratings. Panel A examines the whole sample, which includes all private-labeled MBS

tranches sold between 2000 and 2006. The results are consistent with those in Table III: while initial

yield spread positively predicts future losses for one-rated tranches, it has no statistically significant

predictive power for future losses of two- or three-rated tranches. The coefficient before Log Yield *

Hot is significantly positive for both one- and two-rated tranches but insignificant for three-rated

tranches, which makes sense as tranches with three ratings couldn’t have been shopped. Moreover,

the coefficient before Log Yield * Hot is larger in magnitude for one-rated tranches than for two-

rated ones, implying that during the market booming period, one initial rating may be a cleaner

17
signal for the tranche to have been shopped than two initial ratings, and thereby induces investors to

perform more due diligence.

Panel B of Table IV reports results only for the hot period. Again, initial yield spread has

significant predictive power for future losses only for one-rated tranches. Interestingly, we have

some weak evidence that the market prices three-rated tranches incorrectly during the market

booming period, with higher initial yield spreads predicting lower future losses, but this effect is

weak as the t-stat is only 1.74. Log Yield * Issuer Share is positive but not significant for all three

groups of tranches, perhaps due to a lack of power.

Table V only analyzes the market booming period between 2004 and 2006, but splits the

sample by both the number of initial ratings and the AAA vs. non-AAA category. Panel A examines

only AAA-rated tranches in hot years. In this subsample, we find that initial yield spread has

predictive power for future losses only for two-rated tranches but not for one-rated or three-rated

tranches. Log Yield * Issuer Share is not significant either, whether for one-rated, two-rated, or

three-rated tranches. These results are consistent with the idea that the market somehow recognizes

the “ratings catering” problem for AAA-rated tranches as argued by Griffin and Tang (2013).

Regulated entities, as investors in the AAA market, are typically required to obtain at least two

ratings before making their investments. Therefore, due to the competition pressure to grab more

businesses, the more pessimistic rating agency would scale up their ratings to be consistent with the

more optimistic agency’s AAA rating, leading to rating convergence and higher covered-up credit

risk in the AAA market. However, the market figures out this perverse incentive problem during the

market booming period and thus exerts more effort to produce information and make the initial

yield spread more predictive of future losses for these two-rated AAA tranches.

Panel B of Table V analyzes only non-AAA rated tranches in the hot period and finds very

different results from the AAA market. The loss predictive power of initial yield spread is the

18
strongest for one-rated tranches, weaker but still significant for two-rated tranches, and insignificant

for three-rated tranches. This is in sharp contrast to the “ratings catering” effect in the AAA market:

most investors in the non-AAA market are not required to obtain two or more ratings so the issuers

of such structured finance securities have more freedom to drop the more pessimistic ratings,

leading up to the typical “ratings shopping” problem. Therefore, one-rated non-AAA tranches have

the highest covered-up credit risk imbedded in them, relative to two-rated tranches, which are in

turn more likely to be shopped than three-rated tranches. Perceiving such ratings shopping behavior,

the market performs the most due diligence for one-rated non-AAA tranches to make the initial

yield spread the most informative about future losses, conditional on rating times cohort year fixed

effects.

Another interesting finding from this panel is that Log Yield * Issuer Share is significantly

positive only for two-rated non-AAA tranches, which makes sense because although both large and

small MBS issuers can engage in ratings shopping (that affects both one-rated and two-rated

tranches), ratings catering (that affects only two-rated but not one-rated tranches) could only happen

for deals sold by large issuers because these big players on the MBS market have the bargaining

power to pressure the more pessimistic agency to revise upward their initial ratings. That’s why the

market differentiates between non-AAA tranches sold by large vs. small issuers only for two-rated

but not one-rated tranches.

Table VI includes the interaction terms between the Expected Default Frequency (EDF) of

an average rating category and Hot, issuer market share, as well as the one rating dummy. Since we

control for the full set of average rating categories and their interactions with cohort years, we do

not include EDF itself in our regressions, as its main effect has been absorbed by the rating times

year fixed effects. Panel A shows the results for the pooled sample of AAA- and non-AAA-rated

tranches. Consistent with previous tables, initial yield spread during the hot period is the most

19
predictive for future losses if the tranches have one initial rating, weakly predictive if the tranches

have two initial ratings, and not predictive at all if the tranches have three initial ratings. Initial yield

spread is also more useful in predicting future losses when a tranche has only one initial rating as

opposed to multiple ratings, consistent with the shopping hypothesis. At the same time, the

predictive power of EDF does not differ significantly for tranches issued during the hot vs. cold

markets, or for tranches with one vs. multiple ratings.

Interestingly, EDF * Issuer Share has a significantly negative coefficient for two-rated

tranches in the whole sample period and for both two- and three-rated tranches during the market

booming period. This result suggests that the predictive power of initial ratings for future losses is

much lower if a two- or three-rated tranche is sold by a big MBS issuer than by a smaller issuer,

consistent with the argument by He et al. (2012) that rating agencies have the pressure to inflate

their ratings for big players in the MBS market due to the latter’s enormous bargaining power and

the issuer-pay model. The negative sign of EDF * Issuer Share is in sharp contrast to the

significantly positive sign of Log Yield * Issuer Share in Column (7) of Panel A, suggesting that the

market is somewhat aware of this incentive problem and thus performs more due diligence to make

the MBS pricing informative about the underlying credit risks.

Panel B of Table VI shows that the above pattern in Panel A is mainly driven by the non-

AAA market. During the market booming period (2004-2006), ratings (and thus their EDFs) are

less predictive of future losses when a tranche is issued by a large issuer than by a smaller issuer,

regardless of its number of ratings. In contrast, initial yield spread has a stronger predictive power

of future losses when a two-rated tranche is issued by a large issuer than by a smaller issuer. The

opposite signs of EDF * Issuer Share and Log Yield * Issuer Share are clear evidence of conflict of

interest on the non-AAA ratings market, especially during the market booming years.

20
IV. CONCLUSIONS

With growing evidence revealing problems in the rating process, researchers, practitioners

and regulators have recently focused on ‘rating shopping,’ whereby issuers only purchase and report

the most favorable rating(s) after receiving preliminary opinions from multiple agencies. In this

paper, we study the effects of shopping in the MBS markets by linking cumulative losses on

tranches to the yield spreads at issuance. Our hypothesis is that if the market is suspicious of the

quality of the ratings, then initial yield spreads, which reflect the market’s assessment of the quality

of the tranches, should predict ex post performance conditional on the ratings.

With a large sample of MBS sold between 2000 and 2006, we find that default rates rise

dramatically for tranches sold during market boom years (2004-2006), and tranches with a single

rating (below AAA) have much greater losses than tranches with multiple ratings. We also find that

among non-AAA rated tranches, initial yield spreads predict future losses for single-rated tranches

but not for multi-rated ones. These results suggest that these single-rated tranches have been

‘shopped’ so that pessimistic ratings never reach the market. In the AAA market (each reported

rating is AAA or equivalent), by contrast, most tranches receive two or three ratings and those

ratings almost always agree. Moreover, initial yield spreads predict future losses for AAA-rated

tranches with two ratings. These patterns suggest that rating agencies may have ‘catered’ to

(constrained) investors in the AAA market, who could not purchase a tranche unless it has multiple

AAA ratings. Overall, our results show that rating shopping adversely affects the quality of ratings

in the MBS market, and that investors in the riskier segment of the market (below AAA) price this

risk through higher initial yields.

21
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Ratings, working paper, University of North Carolina.
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backed securities, Working paper, Northwestern University.
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Rene Stulz ed.: The Risks of Financial Institutions (University of Chicago Press).
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Finance 67, 1293-1328.
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competitive pressure for CDO credit ratings, Working paper, the University of Texas at Austin and the
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the pricing of mortgage-backed securities, Journal of Finance 67, 2097-2137.
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evidence, Journal of Financial Economics, forthcoming.

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20. Mathis, J., Jerome McAndrews, and Jean-Charles Rochet, 2009, Rating the raters: Are reputation
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23
 Table I
Summary Statistics of the Mortgage-Backed Securities Sample
This table reports summary statistics of privately-issued mortgage-backed securities (MBS) sold between
2000 and 2006 and whose tranches are rated by at least one credit rating agency at issuance. “Default Rate”
is the cumulative loss rate of an MBS tranche (i.e. the percentage of its balance that has been written off due
to default) from its issuance date up to June 2012. For a tranche with floating coupon, “Initial Yield Spread”
is the fixed markup over the reference rate specified at issuance (e.g. the 1-month LIBOR rate). For a tranche
with fixed or variable coupon, “Initial Yield Spread” is the difference between the initial coupon rate and the
yield of a Treasury security whose maturity is the closest to the tranche’s weighted average life. “Issuer
market share” is calculated as the number of deals originated by an issuer in the previous year divided by the
total number of deals in the same year. “Hot MBS Market” is a dummy that equals 1 if a tranche is issued
between 2004 and 2006, and equals 0 otherwise. “Principal Amount” is the principal amount of a tranche at
issuance. “Weighted Average Life” is the weighted average life of a tranche at issuance. “Fra. of Colla. in
Troubled States” is the fraction of underlying collateral of each tranche originated in the states of Arizona,
California, Florida, or Nevada. “Herfindahl Index of Collateral” is the sum of the squared shares of the
collateral within a deal across each of the top five states (with the largest amount of mortgages), with the
aggregation of all the other states as the sixth category. “Initial Rating” is the average of the ratings a tranche
received at issuance, after we convert the ratings into a numerical value by setting AAA = 1, AA+ = 1.67,
AA = 2, AA– = 2.33, and so on. “Issuer Rating” is the average of the ratings the issuer itself has at issuance
after converting the ratings into a numerical value using the same schedule. “Number of Initial Ratings” is
the number of different ratings a tranche received at issuance, which can equal one (if only one of Moody’s,
S&P, and Fitch rated the tranche), two, or three. “Rating Disagreement” is a dummy that equals 1 if a tranche
receives at least two ratings at issuance and the ratings are different from each other, and equals 0 otherwise
(i.e., if all the ratings are the same or there is only one rating). “Relationship” is a dummy that equals 1 if a
tranche is rated by a relationship agency at issuance where the definition of relationship is given in the paper,
and equals 0 otherwise. “Deal Complexity” is the number of tranches in an MBS deal divided by the total
principal amount of the deal. “Bank Thrift” is a dummy that equals 1 if the issuer is a commercial bank or
thrift, and equals 0 otherwise. “Same Originator Servicer” is a dummy that equals 1 if the originator and the
servicer of the deal are the same, and equals 0 otherwise. “Missing Originator Servicer” is a dummy that
equals 1 if the information about either the originator or the servicer of the deal is missing, and equals 0
otherwise. “Level of Subordination” is the fraction of tranches in the same MBS deal that have a rating the
same as or better than a given tranche based on their principal amount. “Loan to Value (LTV) Ratio” is the
LTV of the underlying collateral for a given tranche at issuance. “Weighted Average Credit Score” is the
weighted average credit score of the underlying collateral for a given tranche at issuance. Panel A provides
summary statistics for variables used in our regressions. Panel B summarizes default rates by the number of
initial ratings and issuance year. Panel C and D summarizes default rates by the number of initial ratings and
issuance year for AAA-rated and non-AAA-rated tranches, respectively.

24
Panel A: Sample statistics for regression variables

Variable Mean Median Std p25 p75 N

Default Rate (in %) 20.00 0.00 38.00 0.00 6.00 73329

Initial Yield Spread (in Basis Points) 125.30 118.25 83.02 53.00 175.00 63349
Issuer Market Share (in %) 5.00 4.00 4.00 3.00 7.00 73329
Hot MBS Market 0.70 1.00 0.46 0.00 1.00 73329
Principal Amount (in Millions) 57.19 15.00 124.38 4.19 50.72 73322
Weighted Average Life (in years) 5.64 4.91 3.35 3.29 7.23 65622
Fra. of Colla. in Troubled States (in %) 45.33 45.60 16.47 34.60 54.70 68109
Herfindahl Index of Collateral 0.34 0.33 0.09 0.29 0.36 68109
Initial Rating 2.08 1.00 1.44 1.00 3.00 73329
Issuer Rating 2.90 2.67 0.94 2.33 3.11 65909
Number of Initial ratings 1.97 2.00 0.58 2.00 2.00 73329
Rating Disagreement 0.11 0.00 0.32 0.00 0.00 73329
Relationship 0.86 1.00 0.35 1.00 1.00 69700
Deal Complexity 0.03 0.02 0.02 0.01 0.04 73329
Bank Thrift 0.59 1.00 0.49 0.00 1.00 73329
Same Originator and Servicer 0.31 0.00 0.46 0.00 1.00 73329
Missing Originator or Servicer 0.51 1.00 0.50 0.00 1.00 73329
Level of Subordination (in %) 92.00 96.00 13.00 92.00 98.00 73311
Loan to Value (LTV) Ratio (in %) 69.56 71.13 14.77 63.80 77.44 71027
Weighted Average Credit Score 703 714 235 672 736 44553

Panel B: Default rates (in %) by number of initial ratings and issuance year

Issuance Year
Number of Initial Ratings 2000 2001 2002 2003 2004 2005 2006
1 Mean 1.5 1.2 2.7 3.0 24.0 54.1 70.8
Median 0.0 0.0 0.0 0.0 0.0 82.4 97.3
Std 10.4 9.4 13.8 12.4 34.1 45.5 42.2
N 565 892 921 2,073 2,536 3,895 2,590

2 Mean 1.4 1.1 0.8 0.7 3.2 18.0 40.7

Median 0.0 0.0 0.0 0.0 0.0 0.0 5.2
Std 10.6 9.1 6.8 6.0 14.1 35.9 46.5
N 1,693 3,192 4,727 6,032 8,463 12,027 12,360

3 Mean 5.2 1.4 1.2 1.1 2.8 21.4 41.3

Median 0.0 0.0 0.0 0.0 0.0 0.0 3.9
Std 22.3 10.4 5.7 5.8 10.7 39.1 47.4
N 229 489 693 772 1,863 3,275 4,042

25
Panel C: Default rates (in %) by number of initial ratings and issuance year for AAA-rated tranches

Issuance Year
Number of Initial Ratings 2000 2001 2002 2003 2004 2005 2006
1 Mean 0.0 0.0 0.0 0.0 0.2 1.1 3.6
Median 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Std 0.0 0.3 0.0 0.1 4.6 7.0 12.0
N 130 187 116 646 475 870 499

2 Mean 0.0 0.1 0.0 0.0 0.0 1.1 6.2

Median 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Std 0.3 2.0 0.1 1.5 1.3 6.9 16.6
N 1371 2646 3703 4483 5420 7348 6477

3 Mean 0.0 0.0 0.0 0.0 0.0 1.0 2.9

Median 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Std 0.1 0.3 0.2 0.2 0.1 9.1 11.4
N 162 327 372 376 754 1331 2033

Panel D: Default rates (in %) by number of initial ratings and issuance year for non-AAA-rated tranches

Issuance Year
Number of Initial Ratings 2000 2001 2002 2003 2004 2005 2006
1 Mean 1.9 1.5 3.1 4.3 29.5 69.4 86.9
Median 0.0 0.0 0.0 0.0 1.7 93.9 98.1
Std 11.8 10.6 14.7 14.8 35.6 40.2 28.8
N 435 705 805 1,427 2,061 3,025 2,091

2 Mean 7.3 5.9 3.7 2.6 9.0 44.4 78.7

Median 0.0 0.0 0.0 0.0 0.0 23.6 100.0
Std 23.5 20.8 14.3 11.3 22.3 45.8 38.6
N 322 546 1,024 1,549 3,043 4,679 5,883

3 Mean 17.9 4.2 2.5 2.1 4.7 35.4 80.2

Median 0.0 0.0 0.0 0.0 0.0 0.0 100.0
Std 38.6 17.8 8.2 8.0 13.6 45.1 37.3
N 67 162 321 396 1,109 1,944 2,009

26
 Table II
Rating and Default Characteristics by Initial Rating Categories and Number of Initial Ratings
This table reports rating and default characteristics by initial rating categories and the number of initial
ratings. We first classify each MBS tranche into a separate rating category based on the best rating it has at
issuance and then report the average rating and default characteristics for tranches in each category. Panel A
uses the whole sample, which includes all private-labeled MBS deals issued between 2000 and 2006 and
rated by at least one credit rating agency at issuance. Panel B uses rated MBS deals that are issued only
during the hot market period, i.e., from 2004 to 2006. For each rating category, “Fraction of 1-rated” is the
percentage of tranches that got only one rating at issuance; “Fraction Disagreement” is the percentage of
two- or three-rated tranches whose initial ratings disagree with each other; “Loss of X-rated” (X=1, 2, and 3,
respectively) is the average default rate over tranches that got X ratings at issuance. Every item in the table is
expressed in percentages.

Panel A: Full sample (2000-2006)

Fraction of 1- Fraction
Loss of 1-rated Loss of 2-rated Loss of 3-rated
rated Disagreement
AAA 7.16 2.90 0.97 1.99 2.22
AA 23.38 35.90 20.14 35.53 25.83
A 25.46 37.34 31.09 42.27 40.36
BBB 27.96 30.57 42.70 49.77 49.41
BB and worse 66.96 14.90 67.02 54.45 68.74

Panel B: Hot-period sample (2004-2006)

Fraction of 1- Fraction
Loss of 1-rated Loss of 2-rated Loss of 3-rated
rated Disagreement
AAA 7.04 4.08 1.53 3.19 2.86
AA 17.89 40.18 34.01 43.46 29.64
A 20.24 43.43 52.44 53.85 47.89
BBB 24.15 34.88 65.36 62.41 60.47
BB and worse 66.10 15.33 79.21 62.93 71.36

27
 Table III
Regression of MBS Default Rates on Initial Yields
This table reports OLS regressions of the MBS default rates on the natural logarithm of initial yield spread
(Log Yield) and other tranche-level, deal-level, and issuer-level characteristics. “One Rating” is a dummy
that equals 1 if a tranche is rated by one credit rating agency at issuance, and equals 0 otherwise. “Two
Rating” is a dummy that equals 1 if a tranche is rated by two credit rating agencies at issuance, and equals 0
otherwise. “Size” is the natural logarithm of the principal amount at issuance. “Missing Credit Score” is a
dummy that equals 1 if the weighted average credit score at issuance is missing, and equals 0 otherwise.
“Rating * Cohort Year” is the full set of dummies that indicate each average initial rating category in each
cohort (issuance) year. The average initial rating category refers to each level of the average ratings a given
tranche received at issuance, after we convert the individual ratings into a numerical value by setting AAA
= 1, AA+ = 1.67, AA = 2, AA– = 2.33, and so on, and then take the arithmetic averages of all the ratings
this tranche receives. Other variables are defined in Table I. Each regression includes separate intercepts for
coupon types (such as floating, fixed, etc.) and deal types given by Bloomberg (such as “ABS Home”,
“CMBS”, “Private CMO Float”, etc.). Standard errors are clustered by issuers. T-statistics are in
parentheses. Panel A uses the whole sample, i.e., from 2000 to 2006. Panel B uses only the hot market
subsample, i.e., from 2004 to 2006. ***, **, and * indicate significance at the 1%, 5%, and 10% levels,
respectively.

Panel A: Full sample (2000-2006)

VARIABLES (1) (2) (3) (4)

Log Yield 0.0034 -0.0058 -0.0105 -0.0144*

(0.77) (-1.23) (-1.30) (-1.74)
Log Yield * Hot 0.0127*** 0.0135*** 0.0148***
(3.80) (3.93) (4.01)
Log Yield * Issuer Share 0.0734 0.0680
(1.00) (0.91)
Log Yield * One Rating 0.0358***
(2.94)
Issuer Share -0.0628 -0.0667 -0.4015 -0.3807
(-0.65) (-0.69) (-1.20) (-1.11)
Size -0.0083*** -0.0082*** -0.0082*** -0.0083***
(-2.84) (-2.85) (-2.85) (-2.90)
Log Weighted Average Life -0.0014 -0.0021 -0.0021 -0.0017
(-0.56) (-0.86) (-0.85) (-0.69)
Fra. of Colla. in Troubled States 0.0022*** 0.0022*** 0.0022*** 0.0022***
(6.43) (6.47) (6.43) (6.44)
Herfindahl Index of Collateral -0.2090*** -0.2091*** -0.2090*** -0.2073***
(-5.64) (-5.66) (-5.70) (-5.66)
Same Originator and Servicer -0.0055 -0.0059 -0.0056 -0.0051
(-0.46) (-0.50) (-0.48) (-0.44)
Missing Originator or Servicer -0.0076 -0.0080 -0.0077 -0.0075
(-0.79) (-0.84) (-0.83) (-0.80)
Issuer Rating 0.0161** 0.0161** 0.0162** 0.0161***
(2.68) (2.69) (2.69) (2.71)
Level of Subordination 0.0444 0.0419 0.0411 0.0436
(1.29) (1.23) (1.22) (1.29)
Relationship -0.0015 -0.0013 -0.0015 -0.0018
(-0.28) (-0.24) (-0.28) (-0.32)

28
 One Rating 0.0344** 0.0343** 0.0346** -0.1377**
(2.57) (2.58) (2.63) (-2.16)
Two Rating 0.0079 0.0080 0.0086 0.0092
(0.74) (0.76) (0.85) (0.91)
Rating Disagreement 0.0412* 0.0406* 0.0405* 0.0410*
(1.89) (1.87) (1.87) (1.88)
Deal Complexity -0.8121*** -0.8096*** -0.8037*** -0.8160***
(-3.48) (-3.48) (-3.49) (-3.55)
Bank Thrift -0.0006 -0.0006 -0.0004 -0.0002
(-0.04) (-0.05) (-0.03) (-0.02)
Loan to Value (LTV) Ratio 0.0015*** 0.0015*** 0.0015*** 0.0015***
(3.74) (3.76) (3.76) (3.78)
Weighted Average Credit Score 0.0000 0.0000 0.0000 0.0000
(0.96) (0.93) (0.92) (0.93)
Missing Credit Score 0.0066 0.0067 0.0064 0.0062
(0.61) (0.63) (0.60) (0.58)

Rating * Cohort Year Yes Yes Yes Yes

Observations 47,652 47,652 47,652 47,652
R-squared 0.736 0.737 0.737 0.737

Panel B: Hot-period sample (2004-2006)

VARIABLES (1) (2) (3)

Log Yield -0.0046 -0.0150 -0.0208**

(-0.67) (-1.50) (-2.09)
Log Yield * Issuer Share 0.1975*** 0.1912**
(2.76) (2.62)
Log Yield * One Rating 0.0692***
(3.43)
Issuer Share -0.0138 -0.8804*** -0.8620**
(-0.09) (-2.87) (-2.71)
Size -0.0146*** -0.0145*** -0.0147***
(-3.61) (-3.62) (-3.67)
Log Weighted Average Life -0.0021 -0.0019 -0.0009
(-0.64) (-0.60) (-0.27)
Fra. of Colla. in Troubled States 0.0029*** 0.0029*** 0.0029***
(6.93) (6.87) (6.96)
Herfindahl Index of Collateral -0.2530*** -0.2539*** -0.2483***
(-4.94) (-5.05) (-4.96)
Same Originator and Servicer -0.0138 -0.0135 -0.0126
(-0.93) (-0.93) (-0.87)
Missing Originator or Servicer -0.0121 -0.0114 -0.0106
(-1.15) (-1.14) (-1.05)
Issuer Rating 0.0165** 0.0167** 0.0166**
(2.25) (2.25) (2.27)
Level of Subordination 0.0543 0.0525 0.0559
(1.35) (1.32) (1.40)
Relationship 0.0075 0.0071 0.0075
(1.18) (1.10) (1.17)
One Rating 0.0522*** 0.0532*** -0.2720***

29
 (3.10) (3.19) (-2.81)
Two Rating 0.0086 0.0102 0.0115
(0.73) (0.93) (1.05)
Rating Disagreement 0.0520** 0.0517** 0.0551**
(2.09) (2.09) (2.20)
Deal Complexity -1.0835*** -1.0614*** -1.0938***
(-3.63) (-3.61) (-3.78)
Bank Thrift 0.0002 0.0003 0.0004
(0.01) (0.02) (0.03)
Loan to Value (LTV) Ratio 0.0022*** 0.0022*** 0.0021***
(3.16) (3.15) (3.15)
Weighted Average Credit Score 0.0000 0.0000 0.0000
(0.67) (0.67) (0.68)
Missing Credit Score 0.0167 0.0158 0.0155
(1.36) (1.29) (1.26)

Rating * Cohort Year Yes Yes Yes

Observations 34,017 34,017 34,017
R-squared 0.718 0.719 0.720

30
 Table IV
Regression of MBS Default Rates on Initial Yields for Subsamples Split by Number of Initial Ratings
This table reports OLS regressions of the MBS default rates on the natural logarithm of initial yield spread (Log Yield) for tranches rated by one, two, and
three credit rating agencies, respectively. All variables are defined in previous tables. Each regression includes separate intercepts for coupon types (such as
floating, fixed, etc.) and deal types given by Bloomberg (such as “ABS Home”, “CMBS”, “Private CMO Float”, etc.). Standard errors are clustered by
issuers. T-statistics are in parentheses. Panel A uses the whole sample, i.e., from 2000 to 2006. Panel B uses only the hot market subsample, i.e., from 2004 to
2006. ***, **, and * indicate significance at the 1%, 5%, and 10% levels, respectively.

Panel A: Full sample (2000-2006)

VARIABLES One Rated Two Rated Three Rated

(1) (2) (3) (1) (2) (3) (1) (2) (3)

Log Yield 0.0307** -0.0065 -0.0111 0.0006 -0.0075 -0.0106 -0.0074 -0.0110 -0.0068
(2.46) (-0.81) (-0.59) (0.12) (-1.38) (-1.23) (-1.10) (-1.30) (-0.56)
Log Yield * Hot 0.0564** 0.0576** 0.0113*** 0.0117*** 0.0044 0.0029
(2.23) (2.30) (3.05) (3.00) (0.48) (0.31)
Log Yield * Issuer Share 0.0667 0.0494 -0.0711
(0.23) (0.73) (-0.59)
Issuer Share 0.3173 0.3033 -0.0215 -0.1821* -0.1848* -0.4089 0.1577 0.1552 0.4672
(1.54) (1.46) (-0.01) (-1.88) (-1.92) (-1.27) (1.03) (1.00) (0.81)
Size 0.0031 0.0042 0.0042 -0.0111*** -0.0110*** -0.0110*** -0.0034 -0.0034 -0.0035
(0.54) (0.73) (0.73) (-3.32) (-3.34) (-3.35) (-0.54) (-0.54) (-0.55)
Log Weighted Average Life 0.0001 -0.0024 -0.0023 -0.0035 -0.0042* -0.0042* 0.0063 0.0061 0.0061
(0.02) (-0.24) (-0.23) (-1.62) (-1.95) (-1.94) (1.38) (1.34) (1.35)
Fra. of Colla. in Troubled States 0.0026*** 0.0026*** 0.0026*** 0.0021*** 0.0022*** 0.0022*** 0.0023*** 0.0023*** 0.0023***
(3.19) (3.23) (3.23) (7.48) (7.51) (7.51) (3.46) (3.47) (3.44)
Herfindahl Index of Collateral -0.2662*** -0.2598*** -0.2597*** -0.1942*** -0.1947*** -0.1950*** -0.2473* -0.2457* -0.2468*
(-2.96) (-2.91) (-2.91) (-5.94) (-5.98) (-6.06) (-1.74) (-1.70) (-1.71)
Same Originator and Servicer 0.0046 0.0054 0.0055 -0.0079 -0.0084 -0.0082 -0.0012 -0.0013 -0.0015
(0.23) (0.27) (0.28) (-1.00) (-1.07) (-1.05) (-0.05) (-0.05) (-0.06)
Missing Originator or Servicer -0.0046 -0.0030 -0.0031 -0.0122 -0.0127 -0.0124 0.0069 0.0070 0.0069
(-0.24) (-0.16) (-0.16) (-1.60) (-1.68) (-1.68) (0.35) (0.35) (0.35)
Issuer Rating 0.0114 0.0111 0.0112 0.0178*** 0.0178*** 0.0179*** 0.0114* 0.0114* 0.0113*
(0.97) (0.96) (0.96) (3.21) (3.25) (3.27) (1.82) (1.82) (1.83)
Level of Subordination 0.0473 0.0427 0.0426 0.0538* 0.0517 0.0509 -0.0092 -0.0097 -0.0091

31
 (0.71) (0.65) (0.65) (1.69) (1.64) (1.64) (-0.09) (-0.10) (-0.09)
Relationship 0.0053 0.0060 0.0058 -0.0063 -0.0060 -0.0062 0.0385** 0.0386** 0.0389**
(0.51) (0.56) (0.53) (-0.80) (-0.77) (-0.80) (2.06) (2.06) (2.04)
Rating Disagreement 0.0493** 0.0487** 0.0487** 0.0810 0.0808 0.0811
(2.06) (2.03) (2.03) (1.15) (1.15) (1.15)
Deal Complexity -1.2619*** -1.2707*** -1.2688*** -0.7164*** -0.7148*** -0.7101*** -0.5179 -0.5189 -0.5206
(-3.68) (-3.72) (-3.72) (-2.97) (-2.98) (-3.00) (-1.11) (-1.11) (-1.11)
Bank Thrift 0.0010 0.0002 0.0004 0.0016 0.0015 0.0017 -0.0041 -0.0040 -0.0036
(0.06) (0.01) (0.03) (0.13) (0.12) (0.14) (-0.30) (-0.30) (-0.27)
Loan to Value (LTV) Ratio 0.0039*** 0.0040*** 0.0040*** 0.0012*** 0.0012*** 0.0012*** -0.0001 -0.0001 -0.0001
(5.97) (5.95) (5.85) (3.98) (4.01) (4.00) (-0.06) (-0.06) (-0.05)
Weighted Average Credit Score -0.0000*** -0.0000*** -0.0000*** 0.0000 0.0000 0.0000 0.0002 0.0002 0.0002
(-3.54) (-3.54) (-3.51) (1.63) (1.60) (1.60) (0.71) (0.65) (0.66)
Missing Credit Score 0.0040 0.0050 0.0052 0.0147 0.0149 0.0147 0.1001 0.0947 0.0974
(0.45) (0.53) (0.56) (1.37) (1.38) (1.37) (0.61) (0.55) (0.56)

Rating * Cohort Year Yes Yes Yes Yes Yes Yes Yes Yes Yes
Observations 7,196 7,196 7,196 33,214 33,214 33,214 7,242 7,242 7,242
R-squared 0.761 0.762 0.762 0.741 0.741 0.741 0.731 0.731 0.731

32
Panel B: Hot-period sample (2004-2006)

VARIABLES One Rated Two Rated Three Rated

(1) (2) (1) (2) (1) (2)

Log Yield 0.0393** 0.0194 -0.0058 -0.0118 -0.0164* -0.0178

(2.09) (0.64) (-0.76) (-1.16) (-1.74) (-1.47)
Log Yield * Issuer Share 0.3779 0.1056 0.0346
(0.66) (1.38) (0.21)
Issuer Share 0.5489* -1.2417 -0.1903 -0.6502* 0.3381 0.1911
(1.96) (-0.46) (-1.42) (-1.94) (1.28) (0.27)
Size 0.0051 0.0050 -0.0207*** -0.0207*** -0.0050 -0.0049
(0.66) (0.65) (-4.72) (-4.74) (-0.61) (-0.60)
Log Weighted Average Life 0.0044 0.0047 -0.0054* -0.0054* 0.0088 0.0089
(0.32) (0.34) (-1.94) (-1.97) (1.45) (1.44)
Fra. of Colla. in Troubled States 0.0037*** 0.0036*** 0.0028*** 0.0028*** 0.0029*** 0.0029***
(3.39) (3.39) (8.26) (8.25) (3.72) (3.69)
Herfindahl Index of Collateral -0.3430** -0.3426** -0.2432*** -0.2441*** -0.2751 -0.2754
(-2.60) (-2.56) (-5.33) (-5.45) (-1.50) (-1.50)
Same Originator and Servicer -0.0069 -0.0072 -0.0164* -0.0164* -0.0009 -0.0008
(-0.27) (-0.28) (-1.70) (-1.71) (-0.03) (-0.03)
Missing Originator or Servicer -0.0046 -0.0052 -0.0195** -0.0191** 0.0097 0.0097
(-0.19) (-0.21) (-2.36) (-2.40) (0.45) (0.45)
Issuer Rating 0.0089 0.0093 0.0187*** 0.0188*** 0.0123* 0.0123*
(0.66) (0.68) (3.00) (3.00) (1.78) (1.77)
Level of Subordination 0.0769 0.0776 0.0721** 0.0708** -0.0070 -0.0074
(0.65) (0.66) (2.17) (2.15) (-0.07) (-0.07)
Relationship 0.0199 0.0195 -0.0053 -0.0056 0.0543** 0.0542**
(1.49) (1.44) (-0.54) (-0.58) (2.38) (2.37)
Rating Disagreement 0.0544** 0.0543** 0.0747 0.0747
(2.16) (2.16) (1.05) (1.05)
Deal Complexity -1.3429** -1.3236** -0.9561*** -0.9432*** -0.5547 -0.5486
(-2.62) (-2.61) (-3.12) (-3.11) (-0.94) (-0.91)
Bank Thrift -0.0066 -0.0064 0.0067 0.0069 0.0004 0.0002
(-0.29) (-0.28) (0.43) (0.45) (0.02) (0.01)
Loan to Value (LTV) Ratio 0.0073*** 0.0072*** 0.0018*** 0.0018*** -0.0002 -0.0002
(4.52) (4.30) (3.69) (3.69) (-0.13) (-0.12)
Weighted Average Credit Score -0.0000*** -0.0000*** 0.0000 0.0000 0.0004 0.0004
(-3.71) (-3.70) (1.40) (1.41) (1.17) (1.18)
Missing Credit Score -0.0014 -0.0005 0.0318** 0.0314** 0.2309 0.2314
(-0.10) (-0.03) (2.57) (2.53) (1.07) (1.07)

Rating * Cohort Year Yes Yes Yes Yes Yes Yes

Observations 4,559 4,559 23,434 23,434 6,024 6,024
R-squared 0.706 0.706 0.728 0.728 0.719 0.719

33
 Table V
Regression of MBS Default Rates on Initial Yields for the Hot-period Subsample Split by
Number of Initial Ratings
This table reports OLS regressions of the MBS default rates on the natural logarithm of initial yield spread (Log
Yield) for tranches rated by one, two, and three credit rating agencies, respectively, by using only the hot-period
subsample (from 2004 to 2006). All variables are defined in previous tables. Each regression includes separate
intercepts for coupon types (such as floating, fixed, etc.) and deal types given by Bloomberg (such as “ABS
Home”, “CMBS”, “Private CMO Float”, etc.). Standard errors are clustered by issuers. T-statistics are in
parentheses. Panel A uses only tranches whose initial ratings are all AAA (or Aaa for Moody’s). Panel B uses
tranches with at least one non-AAA rating at issuance. ***, **, and * indicate significance at the 1%, 5%, and 10%
levels, respectively.

Panel A: AAA only

VARIABLES One Rated Two Rated Three Rated

(1) (2) (1) (2) (1) (2)

Log Yield -0.0045 -0.0152** 0.0120*** 0.0082 0.0022 0.0010

(-0.77) (-2.10) (3.39) (1.56) (0.53) (0.16)
Log Yield * Issuer Share 0.1866 0.0654 0.0284
(1.57) (1.36) (0.19)
Issuer Share 0.4943*** -0.3306 0.0610 -0.2173 -0.1321 -0.2460
(4.80) (-0.61) (1.16) (-0.94) (-0.92) (-0.40)
Size -0.0106* -0.0105** -0.0193*** -0.0193*** -0.0123 -0.0122
(-2.06) (-2.09) (-4.79) (-4.80) (-1.51) (-1.53)
Log Weighted Average Life 0.0074 0.0077 -0.0047 -0.0046 0.0021 0.0022
(0.81) (0.84) (-1.65) (-1.63) (0.48) (0.52)
Fra. of Colla. in Troubled States -0.0001 -0.0000 0.0008*** 0.0008*** 0.0002 0.0002
(-0.12) (-0.09) (4.24) (4.25) (0.75) (0.75)
Herfindahl Index of Collateral -0.0635 -0.0658 -0.0295** -0.0300** 0.1289** 0.1285**
(-1.09) (-1.11) (-2.17) (-2.16) (2.17) (2.18)
Same Originator and Servicer -0.0123 -0.0110 -0.0015 -0.0014 0.0040 0.0042
(-1.00) (-0.87) (-0.28) (-0.25) (0.49) (0.50)
Missing Originator or Servicer -0.0044 -0.0035 -0.0090 -0.0085 0.0061 0.0063
(-0.27) (-0.21) (-1.16) (-1.10) (1.23) (1.26)
Issuer Rating 0.0164*** 0.0163*** 0.0093** 0.0093** 0.0081** 0.0081**
(3.35) (3.31) (2.37) (2.37) (2.44) (2.44)
Level of Subordination -0.0641 -0.0627 0.0208 0.0187 0.0226 0.0217
(-1.16) (-1.12) (1.39) (1.20) (1.22) (1.21)
Relationship -0.0150 -0.0157 -0.0034 -0.0035 -0.0070 -0.0070
(-0.92) (-0.97) (-0.67) (-0.70) (-1.07) (-1.05)
Deal Complexity -0.5855* -0.5485* -0.5137*** -0.5026*** -0.6699 -0.6585
(-1.91) (-1.80) (-3.22) (-3.28) (-1.59) (-1.67)
Bank Thrift 0.0277*** 0.0282*** -0.0019 -0.0018 -0.0075* -0.0079
(3.93) (3.64) (-0.22) (-0.22) (-1.72) (-1.70)
Loan to Value (LTV) Ratio 0.0003 0.0002 0.0006*** 0.0006*** -0.0004 -0.0004
(1.04) (0.82) (3.07) (3.08) (-0.81) (-0.84)
Weighted Average Credit Score -0.0001 -0.0002 0.0000 0.0000 -0.0004 -0.0004
(-0.66) (-0.76) (1.19) (1.19) (-1.54) (-1.54)
Missing Credit Score -0.1101 -0.1254 0.0089* 0.0084 -0.2315 -0.2324
(-0.74) (-0.83) (1.74) (1.59) (-1.55) (-1.55)

34
Cohort Year Fixed Effects Yes Yes Yes Yes Yes Yes
Observations 966 966 14,084 14,084 2,826 2,826
R-squared 0.179 0.181 0.168 0.169 0.101 0.102

Panel B: Non-AAA only

VARIABLES One Rated Two Rated Three Rated

(1) (2) (1) (2) (1) (2)

Log Yield 0.0780*** 0.0554 0.0287* 0.0012 0.0152 0.0464

(3.32) (1.29) (1.75) (0.04) (0.44) (1.20)
Log Yield * Issuer Share 0.4421 0.4921* -0.7785
(0.46) (1.70) (-1.20)
Issuer Share 0.5133 -1.6170 -0.1717 -2.3945* 1.0673* 4.6013
(1.60) (-0.35) (-0.60) (-1.84) (1.94) (1.49)
Size 0.0006 0.0006 -0.0043 -0.0051 0.0338 0.0340
(0.04) (0.04) (-0.54) (-0.64) (1.56) (1.57)
Log Weighted Average Life 0.0179 0.0184 0.0628* 0.0618* -0.0111 -0.0166
(0.46) (0.47) (1.97) (1.91) (-0.15) (-0.23)
Fra. of Colla. in Troubled States 0.0047*** 0.0047***
0.0052*** 0.0052*** 0.0054*** 0.0055***
(3.73) (3.76) (8.14) (8.18) (3.51) (3.46)
Herfindahl Index of Collateral -0.4076*** -0.4073***
-0.6180*** -0.6198*** -0.7103* -0.7165*
(-2.81) (-2.80) (-5.29) (-5.36) (-2.03) (-2.05)
Same Originator and Servicer -0.0036 -0.0044 -0.0444* -0.0456* -0.0115 -0.0119
(-0.12) (-0.15) (-1.96) (-2.00) (-0.28) (-0.28)
Missing Originator or Servicer -0.0039 -0.0050 -0.0366* -0.0357* 0.0163 0.0175
(-0.15) (-0.19) (-1.89) (-1.92) (0.46) (0.49)
Issuer Rating 0.0100 0.01090.0311** 0.0321** 0.0145 0.0133
(0.60) (0.63) (2.41) (2.46) (1.22) (1.16)
Level of Subordination 0.0782 0.07860.1303** 0.1310** -0.0148 -0.0112
(0.60) (0.60) (2.21) (2.22) (-0.10) (-0.07)
Relationship 0.0253 0.0250 -0.0024 -0.0032 0.0908** 0.0916**
(1.56) (1.51) (-0.08) (-0.11) (2.13) (2.13)
Rating Disagreement 0.0525** 0.0516* 0.0767 0.0791
(2.05) (2.03) (1.11) (1.17)
Deal Complexity -1.9746*** -1.9644*** -1.1057 -1.0919 0.8703 0.9082
(-3.10) (-3.10) (-1.50) (-1.49) (0.71) (0.74)
Bank Thrift -0.0126 -0.0128 0.0262 0.0273 0.0134 0.0150
(-0.48) (-0.49) (0.92) (0.96) (0.50) (0.56)
Loan to Value (LTV) Ratio 0.0096*** 0.0095*** 0.0028*** 0.0028*** 0.0002 0.0000
(3.80) (3.64) (3.55) (3.49) (0.07) (0.02)
Weighted Average Credit Score -0.0000*** -0.0000*** 0.0016*** 0.0016*** 0.0020** 0.0020**
(-3.66) (-3.68) (3.88) (3.87) (2.59) (2.60)
Missing Credit Score 0.0005 0.0009 1.1187*** 1.0980*** 1.2218** 1.2388**
(0.03) (0.06) (3.98) (3.98) (2.52) (2.53)

Rating * Cohort Year Yes Yes Yes Yes Yes Yes

Observations 3,593 3,593 9,350 9,350 3,198 3,198
R-squared 0.646 0.646 0.611 0.612 0.637 0.638

35
 Table VI
Regression of MBS Default Rates on Initial Yields for Subsamples Split by Number of Initial Ratings, with EDF Interactions
This table reports OLS regressions of the MBS default rates on the natural logarithm of initial yield spread (Log Yield) together with the interaction terms
involving the Expected Default Frequency (EDF) for tranches rated by one, two, and three credit rating agencies, respectively. For each tranche, we first
find out the EDF for each of its initial ratings by using the mapping provided by the S&P Global Structured Finance 5-year Cumulative Default Rates
ending in Dec. 1999. Then we average over these individual EDFs for each tranche. All other variables are defined in previous tables. Each regression
includes separate intercepts for coupon types (such as floating, fixed, etc.) and deal types given by Bloomberg (such as “ABS Home”, “CMBS”, “Private
CMO Float”, etc.). Standard errors are clustered by issuers. T-statistics are in parentheses. Panel A uses the whole sample, including both AAA-rated and
non-AAA-rated tranches. Panel B uses only the non-AAA-rated tranches. The first four columns in each panel look at the entire sample period from 2000
to 2006, while the latter four look at only the subsample of hot market years from 2004 to 2006. ***, **, and * indicate significance at the 1%, 5%, and
10% levels, respectively.

Panel A: Full sample (both AAA and non-AAA)

Whole Sample (2000-2006) Hot Period (2004-2006)

VARIABLES One/Two/Three One Rated Two Rated Three Rated One/Two/Three One Rated Two Rated Three Rated
(1) (2) (3) (4) (5) (6) (7) (8)
Log Yield -0.0154* -0.0109 -0.0138 -0.0130 -0.0245** 0.0164 -0.0167 -0.0263*
(-1.74) (-0.61) (-1.54) (-1.06) (-2.30) (0.53) (-1.53) (-2.01)
Log Yield * Hot 0.0151*** 0.0575** 0.0120*** 0.0045
(4.03) (2.32) (2.99) (0.50)
Log Yield * Issuer Share 0.0878 0.0625 0.0989 0.0125 0.2472*** 0.4360 0.1904** 0.1887
(1.03) (0.22) (1.39) (0.10) (3.35) (0.77) (2.75) (1.07)
Log Yield * One Rating 0.0348*** 0.0716***
(2.90) (3.42)
EDF * Hot -0.0390
(-0.91)
EDF * Issuer Share -0.0660 0.0090 -0.2081** -0.2133 -0.1360* -0.0738 -0.2458** -0.3368*
(-1.00) (0.15) (-2.17) (-1.52) (-2.01) (-1.40) (-2.54) (-1.91)
EDF * One Rating 0.0035 -0.0033
(0.80) (-0.50)
One Rating -0.1344** -0.2804***
(-2.13) (-2.84)
Two Rating 0.0094 0.0121
(0.95) (1.13)

36
Issuer Share -0.4505 -0.0066 -0.5844 0.1643 -1.0612*** -1.4656 -0.9505*** -0.3535
(-1.18) (-0.00) (-1.68) (0.29) (-3.24) (-0.55) (-2.92) (-0.49)
Size -0.0083*** 0.0042 -0.0109*** -0.0034 -0.0146*** 0.0051 -0.0205*** -0.0047
(-2.90) (0.73) (-3.34) (-0.53) (-3.66) (0.67) (-4.73) (-0.57)
Log Weighted Average Life -0.0017 -0.0024 -0.0041* 0.0063 -0.0007 0.0050 -0.0053* 0.0099
(-0.69) (-0.24) (-1.91) (1.37) (-0.21) (0.36) (-1.93) (1.58)
Fra. of Colla. in Troubled States 0.0022*** 0.0026*** 0.0022*** 0.0023*** 0.0029*** 0.0037*** 0.0028*** 0.0029***
(6.45) (3.24) (7.47) (3.42) (6.94) (3.40) (8.19) (3.68)
Herfindahl Index of Collateral -0.2076*** -0.2597*** -0.1952*** -0.2464 -0.2484*** -0.3428** -0.2446*** -0.2801
(-5.69) (-2.91) (-6.15) (-1.69) (-5.00) (-2.57) (-5.53) (-1.50)
Same Originator and Servicer -0.0049 0.0055 -0.0075 -0.0008 -0.0123 -0.0066 -0.0160 0.0003
(-0.42) (0.27) (-0.97) (-0.03) (-0.85) (-0.25) (-1.69) (0.01)
Missing Originator or Servicer -0.0073 -0.0031 -0.0119 0.0074 -0.0101 -0.0046 -0.0184** 0.0105
(-0.79) (-0.16) (-1.64) (0.38) (-1.02) (-0.19) (-2.37) (0.49)
Issuer Rating 0.0161*** 0.0112 0.0180*** 0.0112* 0.0166** 0.0093 0.0188*** 0.0118
(2.70) (0.96) (3.28) (1.75) (2.25) (0.69) (2.97) (1.64)
Level of Subordination 0.0426 0.0427 0.0470 -0.0115 0.0537 0.0774 0.0660* -0.0118
(1.27) (0.65) (1.54) (-0.12) (1.36) (0.66) (2.02) (-0.12)
Relationship -0.0019 0.0059 -0.0067 0.0390** 0.0073 0.0191 -0.0061 0.0542**
(-0.36) (0.54) (-0.86) (2.05) (1.14) (1.42) (-0.64) (2.37)
Rating Disagreement 0.0566* 0.0539** 0.0830 0.0583** 0.0604** 0.0776
(1.95) (2.14) (1.18) (2.25) (2.29) (1.10)
Deal Complexity -0.8087*** -1.2701*** -0.6948*** -0.4994 -1.0816*** -1.3083** -0.9205*** -0.4736
(-3.57) (-3.74) (-2.99) (-1.06) (-3.82) (-2.58) (-3.09) (-0.79)
Bank Thrift -0.0002 0.0004 0.0021 -0.0045 -0.0000 -0.0068 0.0066 -0.0020
(-0.02) (0.03) (0.17) (-0.33) (-0.00) (-0.30) (0.43) (-0.12)
Loan to Value (LTV) Ratio 0.0015*** 0.0040*** 0.0012*** -0.0001 0.0021*** 0.0072*** 0.0018*** -0.0002
(3.76) (5.84) (3.97) (-0.07) (3.15) (4.30) (3.69) (-0.14)
Weighted Average Credit Score 0.0000 -0.0000*** 0.0000 0.0002 0.0000 -0.0000*** 0.0000 0.0004
(0.93) (-3.49) (1.62) (0.62) (0.69) (-3.65) (1.43) (1.15)
Missing Credit Score 0.0059 0.0052 0.0140 0.0878 0.0150 -0.0006 0.0303** 0.2191
(0.55) (0.56) (1.30) (0.51) (1.22) (-0.04) (2.43) (1.03)

Rating * Cohort Year Yes Yes Yes Yes Yes Yes Yes Yes
Observations 47,652 7,196 33,214 7,242 34,017 4,559 23,434 6,024
R-squared 0.737 0.762 0.741 0.731 0.720 0.706 0.728 0.719

37
Panel B: non-AAA only

Whole Sample (2000-2006) Hot Period (2004-2006)

VARIABLES One/Two/Three One Rated Two Rated Three Rated One/Two/Three One Rated Two Rated Three Rated
(1) (2) (3) (4) (5) (6) (7) (8)
Log Yield -0.0056 -0.0127 0.0000 0.0681* -0.0382 0.0489 -0.0273 0.0102
(-0.21) (-0.36) (0.00) (1.74) (-1.49) (1.13) (-0.89) (0.22)
Log Yield * Hot 0.0370* 0.0979** 0.0067 -0.0016
(1.87) (2.46) (0.23) (-0.04)
Log Yield * Issuer Share 0.3931 0.0570 0.5631* -0.8151 0.9926*** 0.5708 0.9999*** -0.1039
(1.47) (0.10) (1.69) (-1.36) (4.34) (0.59) (3.62) (-0.13)
Log Yield * One Rating 0.0206 0.0891***
(0.99) (3.31)
EDF * Hot -0.0638
(-1.39)
EDF * Issuer Share -0.1672* -0.0307 -0.2623** -0.1898 -0.3665*** -0.1206* -0.4166*** -0.5152*
(-1.84) (-0.53) (-2.23) (-0.82) (-4.95) (-1.88) (-3.53) (-1.81)
EDF * One Rating 0.0054 -0.0064
(1.05) (-0.90)
One Rating -0.0600 -0.3478**
(-0.58) (-2.60)
Two Rating 0.0214 0.0327
(0.85) (1.18)
Issuer Share -1.8717 0.0757 -2.7180* 4.4310 -4.2606*** -2.1354 -4.3663*** 1.9477
(-1.49) (0.03) (-1.84) (1.53) (-3.92) (-0.46) (-3.48) (0.55)
Size 0.0014 0.0033 0.0008 0.0274 -0.0003 0.0008 -0.0047 0.0341
(0.20) (0.29) (0.11) (1.52) (-0.04) (0.05) (-0.58) (1.58)
Log Weighted Average Life 0.0469** -0.0205 0.0625** -0.0087 0.0447 0.0195 0.0613* -0.0214
(2.07) (-0.57) (2.14) (-0.16) (1.62) (0.50) (1.87) (-0.30)
Fra. of Colla. in Troubled States 0.0041*** 0.0033*** 0.0043*** 0.0046*** 0.0052*** 0.0047*** 0.0052*** 0.0054***
(6.66) (3.36) (7.76) (3.26) (7.19) (3.76) (8.18) (3.45)
Herfindahl Index of Collateral -0.4512*** -0.3099*** -0.5817*** -0.6391** -0.4984*** -0.4077*** -0.6223*** -0.7193*
(-5.40) (-3.08) (-5.67) (-2.12) (-4.50) (-2.82) (-5.41) (-2.05)
Same Originator and Servicer -0.0133 0.0080 -0.0243 -0.0059 -0.0306 -0.0033 -0.0464** -0.0114
(-0.60) (0.33) (-1.21) (-0.14) (-1.13) (-0.11) (-2.05) (-0.27)
Missing Originator or Servicer -0.0072 -0.0048 -0.0222 0.0153 -0.0136 -0.0041 -0.0348* 0.0173

38
 (-0.41) (-0.22) (-1.38) (0.47) (-0.72) (-0.15) (-1.92) (0.48)
Issuer Rating 0.0252** 0.0118 0.0344*** 0.0125 0.0248* 0.0110 0.0328** 0.0138
(2.09) (0.84) (2.79) (1.12) (1.78) (0.64) (2.47) (1.16)
Level of Subordination 0.1022 0.0477 0.1153* -0.0278 0.1099 0.0784 0.1288** -0.0168
(1.29) (0.70) (1.88) (-0.18) (1.27) (0.61) (2.19) (-0.11)
Relationship 0.0065 0.0080 0.0086 0.0800** 0.0257* 0.0244 -0.0047 0.0903**
(0.59) (0.58) (0.37) (2.39) (1.99) (1.50) (-0.16) (2.13)
Rating Disagreement 0.0650** 0.0542** 0.0824 0.0658** 0.0603** 0.0847
(2.40) (2.28) (1.19) (2.49) (2.31) (1.26)
Deal Complexity -1.2261** -1.6737*** -0.7705 0.6971 -1.4836** -1.9428*** -1.0564 0.9294
(-2.23) (-3.71) (-1.17) (0.69) (-2.33) (-3.06) (-1.45) (0.75)
Bank Thrift 0.0021 -0.0032 0.0218 0.0048 0.0011 -0.0137 0.0272 0.0117
(0.09) (-0.18) (0.80) (0.21) (0.04) (-0.53) (0.96) (0.43)
Loan to Value (LTV) Ratio 0.0024*** 0.0053*** 0.0024*** 0.0001 0.0030*** 0.0095*** 0.0027*** 0.0001
(3.17) (5.52) (3.83) (0.05) (2.93) (3.64) (3.46) (0.05)
Weighted Average Credit Score 0.0000 -0.0000*** 0.0014*** 0.0011 0.0000 -0.0000*** 0.0016*** 0.0020**
(0.54) (-3.02) (4.50) (1.58) (0.33) (-3.60) (3.83) (2.58)
Missing Credit Score 0.0105 0.0021 0.9683*** 0.6709 0.0224 0.0003 1.0690*** 1.2110**
(0.33) (0.19) (4.49) (1.51) (0.75) (0.02) (3.93) (2.51)

Rating * Cohort Year Yes Yes Yes Yes Yes Yes Yes Yes
Observations 20,675 5,670 11,245 3,760 16,141 3,593 9,350 3,198
R-squared 0.671 0.747 0.663 0.673 0.605 0.647 0.613 0.638

39
 (in %)
Average Default Rates (Full Sample)
80

60

40

20

0
AAA AA A BBB BB and Worse

One Rated Two Rated Three Rated

Fig. 1 (A)

(in %) Average Default Rates (Hot Period)
100
80
60
40
20
0
AAA AA A BBB BB and Worse

One Rated Two Rated Three Rated

Fig. 1 (B)

(in %) Average Default Rates (Hot Period, Non‐disagreement)
100
80
60
40
20
0
AAA AA A BBB BB and Worse

One Rated Two Rated Three Rated

Fig. 1 (C)

Fig. 1 Average default rates for different rating categories by the number of initial
ratings. This figure shows the average default rates for tranches with different rating
categories by their number of initial ratings. Fig. 1 (A) gives the results for the whole sample
from 2000 to 2006. Fig. 1 (B) gives the results for the hot years from 2004 to 2006. Fig. 1
(C) examines tranches with identical (non-disagreeing) initial ratings during the hot market
period.