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Ruodu Wang: Self-Consistency, Subjective Pricing, and a Theory of Credit Rating

Tuesday, April 21, 2020

Ruodu WangA new research paper Self-Consistency, Subjective Pricing, and a Theory of Credit Rating by Professor Ruodu Wang and his co-authors was recently featured in a Bloomberg news article: Riskier CLOs Get Big Boost From S&P in ‘New Ratings Shopping’.

In the paper, Ruodu and his co-authors propose a theory for rating financial securities, which is the first rigorous treatment of the question of what is an economically sensible way of rating financial instruments with credit risk, such as defaultable debts, Collateralized Debt Obligations (CDO), and Collateralized Loan Obligations (CLO). The study reveals empirical evidences in the post-Dodd-Frank period (i.e., after July 2010) that the issuers of CDO/CLO can take advantage of the absence of an important theoretical property, called self-consistency in the paper. With several theoretical results, the co-authors demonstrate that the lack of such a property may lead to the serious issue of tranche maximization which is widely seen in today's CLO market. As credit rating and rating agencies play a crucial part for the security of the modern financial system and the economy, flawed rating mechanisms could further lead to adverse financial consequences under today's extreme financial stress.
 

To view the paper, please visit Social Science Research Network (SSRN).


This paper was a joint work by: Nan Guo, Steven Kou, Bin Wang and Ruodu Wang
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