Do Investors Rely Only On Ratings? The Case Of Mortgage-Backed Securities

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Executive Summary

This paper presents evidence that the prices at origination of residential mortgage backed securities contain information on the quality of the underlying asset pools above what is rejected in the ratings. Yield spreads at issuance predict both future downgrades and defaults even after the information contained in ratings is taken into account. This holds for all rating classes except triple-A. Yield spreads of the highest rated securities have no predictive power for future performance. This suggests that investors in triple-A were less informed about the quality of the securitized assets than investors in riskier, more information sensitive securities.

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