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Optimal Form of Retention for Securitized Loans under Moral Hazard

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  • Georges Dionne

    (Department of Finance, HEC Montréal, 3000 Côte-Sainte-Catherine Road, Montreal, QC H3T 2A7, Canada)

  • Sara Malekan

    (Department of Management, Science and Technology, Amirkabir University of Technology, 424 Hafez Ave, Tehran 15875-4413, Iran)

Abstract

We address the moral hazard problem of securitization using a principal-agent model where the investor is the principal and the lender is the agent. Our model considers structured asset-backed securitization with a credit enhancement (tranching) procedure. We assume that the originator can affect the default probability and the conditional loss distribution. We show that the optimal form of retention must be proportional to the pool default loss even in the absence of systemic risk when the originator can affect the conditional loss given default rate, yet the current regulations propose a constant retention rate.

Suggested Citation

  • Georges Dionne & Sara Malekan, 2017. "Optimal Form of Retention for Securitized Loans under Moral Hazard," Risks, MDPI, vol. 5(4), pages 1-13, October.
    • Handle: RePEc:gam:jrisks:v:5:y:2017:i:4:p:55-:d:115890
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    More about this item

    Keywords

    securitization; optimal retention; moral hazard; tranching; credit enhancement; conditional loss distribution;
    All these keywords.

    JEL classification:

    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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