Joint Obligation Ratings in Consumer ABS

Abstract

Current rating agency practices do not appear to factor into the ratings of insured consumer asset-backed securities (ABS) the effects of correlation between an insurer default and a transaction default. As a result, the rating agencies assign lower ratings to insured bonds from consumer ABS transactions even when the performance of the underlying assets and the performance of the insurer may have a low correlated probability of default. In this article, the authors’ goal is to show the significant rating impact of correlation. They provide a detailed analysis and conclude that a significant rating benefit could be conferred by the proper inverse correlation structure.

TOPICS: Asset-backed securities (ABS), portfolio theory, portfolio construction