Incentives and the Economics of Securitization

This chapter addresses the economics of securitization at a fundamental level. We first see how, in theory, securitization should not exist. Then we look into various economic models that can explain not only why securitization actually exists, but also why it makes use of certain fundamental structuring tools. We effectively decompose the notion of the existence of securitization into the existence of its fundamental components. First, for securitization to exist, selling assets needs to be optimal. Second, for securitization to exist as debt issuance, there has to be some optimality in debt versus equity or other forms of securities issuance. To address the first part of the question, we look through various explanatory factors which are considered to be taxes, bankruptcy or regulatory costs, and certain synergies and asymmetries in information. We analyze a range of models and discuss their relevance in light of empirical studies. Then, we turn to the justification of debt financing in securitization. We study various models explaining how the optimal financing security that will not be mispriced by investors takes the form of debt. Finally, we look into how well these models account for reality.