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Securitization and Optimal Retention under Moral Hazard

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  • Sara Malekan
  • Georges Dionne

Abstract

Securitization is one of the most important innovations in financial markets. It is a process of converting illiquid loans that cannot be sold readily to third-party investors into liquid securities and selling them to dispersed investors. As a result, securitization improves liquidity in capital markets by allowing originators to remove the issued loans from its balance sheet and use the proceeds for other purposes or even to originate new loans. In spite of all its advantages, securitization is often suspected of being one of the main reasons for the recent financial crisis. One concern that is frequently raised in the literature is that securitization leads to moral hazard in lender screening and monitoring. By selling loans to investors and removing them from their books, banks have a lesser incentive to carefully evaluate and monitor borrowers’ credit quality to ensure that they can repay the loans, because the risk of delinquencies falls on investors rather than lenders. One problem in the literature is that the analysis of securitization is very general and suffers from a lack a specific security design analysis under asymmetric information. We address the moral hazard problem using a principal-agent model where the investor is the principal and the lender is the agent. We show that the optimal contract must contain a retention clause in the presence of moral hazard.

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Bibliographic Info

Paper provided by CIRPEE in its series Cahiers de recherche with number 1221.

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Date of creation: 2012
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Handle: RePEc:lvl:lacicr:1221

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Related research

Keywords: Securitization; optimal retention; moral hazard; principal-agent model; default; screening monitoring;

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References

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  1. Ingo Fender & Janet Mitchell, 2009. "The future of securitisation: how to align incentives," BIS Quarterly Review, Bank for International Settlements, September.
  2. Christine A. Parlour & Guillaume Plantin, 2008. "Loan Sales and Relationship Banking," Journal of Finance, American Finance Association, vol. 63(3), pages 1291-1314, 06.
  3. Atif Mian & Amir Sufi, 2009. "The Consequences of Mortgage Credit Expansion: Evidence from the U.S. Mortgage Default Crisis," The Quarterly Journal of Economics, MIT Press, vol. 124(4), pages 1449-1496, November.
  4. Benjamin J. Keys & Tanmoy Mukherjee & Amit Seru & Vikrant Vig, 2010. "Did Securitization Lead to Lax Screening? Evidence from Subprime Loans," The Quarterly Journal of Economics, MIT Press, vol. 125(1), pages 307-362, February.
  5. Ingo Fender & Janet Mitchell, 2009. "Incentives and tranche retention in securitisation : a screening model," Working Paper Research 177, National Bank of Belgium.
  6. Berndt, Antje & Gupta, Anurag, 2009. "Moral hazard and adverse selection in the originate-to-distribute model of bank credit," Journal of Monetary Economics, Elsevier, vol. 56(5), pages 725-743, July.
  7. Peter M. DeMarzo, 2005. "The Pooling and Tranching of Securities: A Model of Informed Intermediation," Review of Financial Studies, Society for Financial Studies, vol. 18(1), pages 1-35.
  8. Joshua Coval & Jakub Jurek & Erik Stafford, 2009. "The Economics of Structured Finance," Journal of Economic Perspectives, American Economic Association, vol. 23(1), pages 3-25, Winter.
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Cited by:
  1. Pituwan Poramapojn, 2012. "Effect of Securitization on the Bank’s Equity Risk in the U.S," Applied Economics Journal, Kasetsart University, Faculty of Economics, Center for Applied Economic Research, vol. 19(1), pages 68-86, June.

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