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Skin in the Game and Moral Hazard

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  • Chemla, Gilles
  • Hennessy, Christopher A.
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    Abstract

    What determines equilibrium securitization levels, and should they be regulated? To address these questions we develop a model where originators can exert unobservable effort to increase asset quality, subsequently having private information regarding quality when selling ABS to rational investors. In equilibrium, all originators have low/zero retentions if they are financially constrained and/or prices are su¢ ciently informative. Asymmetric information lowers effort incentives in all equilibria. Effort is promoted by junior retentions, investor sophistication, and informative prices. Optimal regulation promotes effort while accounting for investor-level externalities. It entails either a menu of junior retentions or a single junior retention with size decreasing in price informativeness. Mandated market opacity is only optimal amongst regulations failing to induce originator effort.

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    Bibliographic Info

    Paper provided by Paris Dauphine University in its series Economics Papers from University Paris Dauphine with number 123456789/11540.

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    Date of creation: Jan 2013
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    Publication status: Published in Cahiers de la Chaire Finance et Développement Durable, 2013
    Handle: RePEc:dau:papers:123456789/11540

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    Related research

    Keywords: Securitization; skin in the game; risk-sharing; moral hazard;

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    1. Dow, James, 1998. "Arbitrage, Hedging, and Financial Innovation," Review of Financial Studies, Society for Financial Studies, vol. 11(4), pages 739-55.
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    7. Hartman-Glaser, Barney & Piskorski, Tomasz & Tchistyi, Alexei, 2012. "Optimal securitization with moral hazard," Journal of Financial Economics, Elsevier, vol. 104(1), pages 186-202.
    8. Gary Gorton & George Pennacchi, 1990. "Banks and Loan Sales: Marketing Non-Marketable Assets," NBER Working Papers 3551, National Bureau of Economic Research, Inc.
    9. Ernst Maug, 1998. "Large Shareholders as Monitors: Is There a Trade-Off between Liquidity and Control?," Journal of Finance, American Finance Association, vol. 53(1), pages 65-98, 02.
    10. Charles Kahn & Andrew Winton, 1998. "Ownership Structure, Speculation, and Shareholder Intervention," Journal of Finance, American Finance Association, vol. 53(1), pages 99-129, 02.
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