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Default risk sharing between banks and markets: the contribution of collateralized debt obligations

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  • Günter Franke

    ()
    (Department of Economics, University of Konstanz)

  • Jan Pieter Krahnen

    (Center for Financial Studies, Goethe-University Frankfurt)

Abstract

This paper contributes to the economics of financial institutions risk management by exploring how loan securitization affects their default risk, their systematic risk, and their stock prices. In a typical CDO transaction a bank retains through a first loss piece a very high proportion of the default losses, and transfers only the extreme losses to other market participants. The size of the first loss piece is largely driven by the average default probability of the securitized assets. If the bank sells loans in a true sale transaction, it may use the proceeds to expand its loan business, thereby affecting systematic risk. For a sample of European CDO issues, we find an increase of the banks’ betas, but no significant stock price effect around the announcement of a CDO issue.

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Bibliographic Info

Paper provided by Center of Finance and Econometrics, University of Konstanz in its series CoFE Discussion Paper with number 05-04.

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Length: 38 pages
Date of creation: 18 Aug 2005
Date of revision:
Handle: RePEc:knz:cofedp:0504

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