Weather risk is a major source of income fluctuations for rural households in developing countries. Rosenzweig and Binswanger (1993), for example, find that the delay of the monsoon in semi-arid India can have considerable negative effects on agricultural yield and profits. If the monsoon were to arrive one standard deviation late, the poorest quartile of the households in their data would experience a reduction of 35 percent in agricultural profits, while for the median household, the drop would be of 15 percent.
With complete and frictionless financial markets, households would be able to protect consumption from weather shocks fairly well. But because formal insurance markets in developing countries are typically missing, households have to rely on the ex-ante and ex-post risk coping strategies that typically trade expected profits for lower risk (Walker and Ryan, 1990).
Liquidity Risk Management (LRM) has become increasingly vital in the banking industry, especially with the recent financial meltdown and economic down-turn. During the crisis, increasing credit concerns and feeble market liquidity animated a cycle of deteriorating asset market values and deleveraging. Authorities around the world sort for a solution as inter-bank lending came to a halt, credit risk and capital flight became common-place, and banks were on their knees in search of liquidity.
This study seeks to determine the sources of credit risk associated with asset securitizations and whether credit rating agencies and the bond market differ in their perception of the sources of this risk. We focus on credit risk because the transfer of credit risk is a key motivation for asset securitizations and it raises difficult accounting issues. By addressing whether perceptions of credit risk differ for credit rating agencies and the bond market, we provide evidence on critics’ allegations that rating agencies were not diligent in assessing the effects of “off-balance sheet” activities, particularly asset securitizations, when developing credit ratings. We find that asset securitizations are positively associated with the securitizing firm’s credit risk, but credit rating agencies and the bond market differ in their perception of the sources of this risk.
In a typical securitization transaction, a firm transfers assets to a special purpose securitization entity (SPE) and, in exchange, receives cash obtained from other investors in the SPE and a retained interest in the transferred assets. Because the firm’s continuing involvement with the securitized assets can be complex, it is not straightforward to determine whether all of the risk of the assets resides with the SPE, all of the risk of the assets resides with the firm, or whether some of the risk of the assets resides with the SPE and some with the firm.
