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

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Author Info
Günter Franke () (Department of Economics, University of Konstanz)
Jan Pieter Krahnen (Center for Financial Studies, Goethe-University Frankfurt)

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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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Publisher 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
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Handle: RePEc:knz:cofedp:0504

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Find related papers by JEL classification:
D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information
G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Mortgages
D74 - Microeconomics - - Analysis of Collective Decision-Making - - - Conflict; Conflict Resolution; Alliances

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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    Other versions:
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Pagès, H., 2009. "Bank incentives and optimal CDOs," Documents de Travail 253, Banque de France. [Downloadable!]
  2. Philip Strahan, 2008. "Liquidity Production in 21st Century Banking," NBER Working Papers 13798, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  3. Minton, Bernadette & Sanders, Anthony & Strahan, Philip E., 2004. "Securitization by Banks and Finance Companies: Efficient Financial Contracting or Regulatory Arbitrage?," Working Paper Series 2004-25, Ohio State University, Charles A. Dice Center for Research in Financial Economics. [Downloadable!]
  4. Christina E. Bannier & Dennis N. Hänsel, 2006. "Determinants of banks' engagement in loan securitization," Working Paper Series: Finance and Accounting 171, Department of Finance, Goethe University Frankfurt am Main. [Downloadable!]
  5. Minton, Bernadette & Stulz, Rene & Williamson, Rohan, 2008. "How Much Do Banks Use Credit Derivatives to Hedge Loans?," Working Paper Series 2008-1, Ohio State University, Charles A. Dice Center for Research in Financial Economics. [Downloadable!]
  6. Jan Pieter Krahnen & Christian Wilde, 2008. "Risk Transfer with CDOs," Working Paper Series: Finance and Accounting 187, Department of Finance, Goethe University Frankfurt am Main. [Downloadable!]
    Other versions:
  7. Abel Elizalde, 2006. "CREDIT RISK MODELS IV: UNDERSTANDING AND PRICING CDOs," Working Papers wp2006_0608, CEMFI. [Downloadable!]
  8. Jan Pieter Krahnen & Christian Wilde, 2006. "Risk Transfer with CDOs and Systemic Risk in Banking," CFS Working Paper Series 2006/04, Center for Financial Studies. [Downloadable!]
    Other versions:
  9. Günter Franke & Julia Hein, 2007. "Securitisation of Mezzanine Capital in Germany," CoFE Discussion Paper 07-07, Center of Finance and Econometrics, University of Konstanz. [Downloadable!]
    Other versions:
  10. Günter Franke & Markus Herrmann & Thomas Weber, 2007. "Information asymmetries and securitization design," CoFE Discussion Paper 07-10, Center of Finance and Econometrics, University of Konstanz. [Downloadable!]
  11. Beverly Hirtle, 2008. "Credit derivatives and bank credit supply," Staff Reports 276, Federal Reserve Bank of New York. [Downloadable!]
    Other versions:
  12. Gersbach, Hans & Wenzelburger, Jan, 2007. "Sophistication in Risk Management, Bank Equity, and Stability," CEPR Discussion Papers 6353, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  13. Raghuram G. Rajan, 2005. "Has financial development made the world riskier?," Proceedings, Federal Reserve Bank of Kansas City, issue Aug, pages 313-369. [Downloadable!]
    Other versions:
  14. Hänsel, Dennis N. & Bannier, Christina E., 2008. "Determinants of European banks' engagement in loan securitization," Discussion Paper Series 2: Banking and Financial Studies 2008,10, Deutsche Bundesbank, Research Centre. [Downloadable!]
  15. Minton, Bernadette A. & Stulz, Rene M. & Williamson, Rohan, 2005. "How Much Do Banks Use Credit Derivatives to Reduce Risk?," Working Paper Series 2005-17, Ohio State University, Charles A. Dice Center for Research in Financial Economics. [Downloadable!]
  16. Bernadette A. Minton & René Stulz & Rohan Williamson, 2005. "How Much Do Banks Use Credit Derivatives to Reduce Risk?," NBER Working Papers 11579, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  17. Antonio Nicolo' & Loriana Pelizzon, 2005. "Credit Derivatives: Capital Requirements and Strategic Contracting," "Marco Fanno" Working Papers 0006, Dipartimento di Scienze Economiche "Marco Fanno". [Downloadable!]
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