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Optimal Securitization with Heterogeneous Investors

Author

Listed:
  • Semyon Malamud

    (Ecole Polytechnique Federale de Lausanne; Centre for Economic Policy Research (CEPR); Swiss Finance Institute)

  • Huaxia Rui

    (University of Rochester - Simon Business School)

  • Andrew B. Whinston

    (Andrew B. Whinston)

Abstract

We solve the problem of optimal securitization for an issuer facing heterogeneous investors with arbitrary time and risk preferences. We show that the optimal securitization is characterized by multiple nonlinear tranches, and each investor gets a portfolio of these tranches. In particular, when all agents have CARA utilities, the linear tranching is optimal, with the number of tranches being less than or equal to the number of investors. To the best of our knowledge, this is the first model in the literature that explains the appearance of multiple tranches in the security design and the relation of the tranche thresholds to microeconomic characteristics. We show that the boundaries of the tranches can be efficiently calculated through a fixed point of a contraction mapping, and we develop new powerful techniques that are generally applicable for numerical calculation of constrained Pareto-efficient allocations. We use these contraction mapping techniques to derive a number of comparative static results for optimal securitization. The model generates theoretical predictions and numerical simulations that agree with several recent empirical findings concerning the CDO structure.

Suggested Citation

  • Semyon Malamud & Huaxia Rui & Andrew B. Whinston, 2010. "Optimal Securitization with Heterogeneous Investors," Swiss Finance Institute Research Paper Series 10-10, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp1010
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    File URL: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1563522
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    Cited by:

    1. Sascha Tobias Wengerek & Benjamin Hippert & André Uhde, 2019. "Risk allocation through securitization - Evidence from non-performing loans," Working Papers Dissertations 58, Paderborn University, Faculty of Business Administration and Economics.

    More about this item

    Keywords

    securitization; tranching; heterogeneity; mortgage backed securities; asset backed securities;
    All these keywords.

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage

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