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Convertible tranche in securitization

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  • Zhang, Xiong

Abstract

It is essential to motivate a banker in order to diligently screen borrowers if the banker has the option to securitize its loans and sell part of it to outside investors. Based on theoretical analysis and experimental research, we propose that issuing a convertible tranche in securitization can not only motivate a banker to exert greater effort to screen loans, but also lead to higher prices for selling tranches. A convertible tranche can also increase the sale proportion of the loan pool under the condition of ensuring socially optimal effort, thereby increasing more social surplus than a static tranche. The optimal convertible proportion is positively related to the natural proportion of high-default-risk borrowers, the borrowers’ default possibilities, and the screening cost. The value of the convertible option is higher in an economic downturn. Consequently, not only should regulators formulate policies on the convertible proportion under consideration of the economic state, but also adopt a counter-cyclical policy.

Suggested Citation

  • Zhang, Xiong, 2020. "Convertible tranche in securitization," The North American Journal of Economics and Finance, Elsevier, vol. 52(C).
    • Handle: RePEc:eee:ecofin:v:52:y:2020:i:c:s1062940820300735
    DOI: 10.1016/j.najef.2020.101176
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    More about this item

    Keywords

    Securitization; Convertible; Tranche; Screen; Experiment;
    All these keywords.

    JEL classification:

    • C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • G01 - Financial Economics - - General - - - Financial Crises
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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