WHY DID CREDIT RATING FAIL IN CREDIT CRISIS.docVIP

WHY DID CREDIT RATING FAIL IN CREDIT CRISIS 　　When it comes to sub-prime mortgage crisis， we will still take a deep breath to calm down. The crisis destroyed economy， trades and even people’s life. A large number of victims are still scraping their lives. We need to know why？ What are the underlying forces of credit crisis？ Factors come from different dimensions； however， this paper will focus on the credit rating failure. 　　This term paper aims to find the reason behind credit rating failure in credit crisis focusing on the overreliance of risk estimating model and the factors of functional inefficient market. Reasons come from four aspects， including corporate dishonest， conflicts of interest loose regulation and lack of transparency. 　　Key Words： Credit rating， CRAs， Conflicts of Interest 　　1、Overreliance on Credit Rating Models 　　Usually， CRAs use credit rating models to quantified credit rate of derivative bonds. Hong Liang （2006 ）1 pointed out three models that employed by CRAs： 　　1）Traditional binomial probability distribution 　　2）Monte Carol simulation 　　3）Risk estimation model on MBS 　　“Financial firm’s overreliance and overconfidence on untested risk models led to an underestimation of risk， which led to excessive positions in the mortgage market and ultimately to the financial crisis” 2. 　　Through this citation， we will easily figure out that financial firms rely too much on risk models. However， these models may have performed poorly in the 2008 crisis for a number of reasons3. 　　First， the data encapsulated by risk models is selected from a relatively short history that is limited. Second， those credit rating models are not “structural models”， but the “reduced-form” models. “reduced-form” model isn’t account for underlying changes in supply and demand behavior. Thus， it is hard for it to examine possible changes in adverse selection or moral hazard behavior4. 　　2. Conflicts of Interest 　　Conflicts of interest formed in the supply chain