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Structured finance and the financial turmoil of 2007-2008: and introductory overview

  • Sarai Criado

    ()

    (Banco de España)

  • Adrian van Rixtel

    ()

    (Banco de España)

This paper provides an overview of the most important structured finance instruments in the context of the development of the financial turmoil that started in the third quarter of 2007 and continued into 2008. These financial market tensions were triggered by concerns about exposures of financial institutions to the most risky segment of the US mortgage markets -the so-called subprime mortgage market- and related financial instruments, which predominantly were related to structured finance. As structured finance has developed very fast in recent years and often involves highly complex financial instruments and techniques, which may not be understood completely beyond a small circle of financial market experts, the aim of this paper is to provide an introduction to these instruments that may serve to better understand the specific characteristics of the financial turmoil. In this context, the paper proposes a specific classification of structured finance and discusses both securitizations and credit derivatives with the aim of explaining their specific contributions to the development of the financial turmoil. To this extent, the paper differentiates between two main categories of structured finance instruments. The first one played an important role in the initiation and propagation of the turmoil and includes mortgage-backed securities (MBS), asset backed commercial paper (ABCP) and collateralized debt obligations (CDOs), both cash flow and synthetic. The second category of structured finance instruments involves those that have been more instrumental in monitoring the crisis, both for market participants and policymakers. The main instruments here are credit default swaps (CDS), of which examples are presented for both single name and index contracts. Finally, the paper provides an overview of the specific contagion channels involving various structured finance instruments. This will be conducted on the basis of examples for hypothetical financial institutions that are nevertheless representative for real world developments such as they occurred in the course of 2007 and 2008.

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File URL: http://www.bde.es/f/webbde/SES/Secciones/Publicaciones/PublicacionesSeriadas/DocumentosOcasionales/08/Fic/do0808e.pdf
File Function: First version, August 2008
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Paper provided by Banco de Espa�a in its series Banco de Espa�a Occasional Papers with number 0808.

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Length: 43 pages
Date of creation: Aug 2008
Date of revision:
Handle: RePEc:bde:opaper:0808
Contact details of provider: Web page: http://www.bde.es/
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  1. Adam B. Ashcraft & Til Schuermann, 2008. "Understanding the securitization of subprime mortgage credit," Staff Reports 318, Federal Reserve Bank of New York.
  2. Scheicher, Martin, 2008. "How has CDO market pricing changed during the turmoil? Evidence from CDS index tranches," Working Paper Series 0910, European Central Bank.
  3. Paul S. Mills & John Kiff, 2007. "Money for Nothing and Checks for Free; Recent Developments in U.S. Subprime Mortgage Markets," IMF Working Papers 07/188, International Monetary Fund.
  4. repec:sae:ecolab:v:16:y:2006:i:2:p:1-2 is not listed on IDEAS
  5. Frank Fabozzi & Vinod Kothari, 2007. "Securitization: The Tool of Financial Transformation," Yale School of Management Working Papers amz2495, Yale School of Management, revised 01 Jul 2007.
  6. Gary Gorton & Nicholas Souleles, 2005. "Special Purpose Vehicles and Securitization," NBER Working Papers 11190, National Bureau of Economic Research, Inc.
  7. Antonio Cesare, 2006. "Do Market-based Indicators Anticipate Rating Agencies? Evidence for International Banks," Economic Notes, Banca Monte dei Paschi di Siena SpA, vol. 35(1), pages 121-150, 02.
  8. M. Ruth & K. Donaghy & P. Kirshen, 2006. "Introduction," Chapters, in: Regional Climate Change and Variability, chapter 1 Edward Elgar.
  9. Ronel Elul, 2005. "The economics of asset securitization," Business Review, Federal Reserve Bank of Philadelphia, issue Q3, pages 16-25.
  10. Douglas Lucas & Laurie Goodman & Frank Fabozzi, 2007. "Collateralized Debt Obligations and Credit Risk Transfer," Yale School of Management Working Papers amz2503, Yale School of Management.
  11. Cousseran, O. & Rahmouni, I., 2005. "The CDO market Functioning and implications in terms of financial stability," Financial Stability Review, Banque de France, issue 6, pages 43-62, June.
  12. Adrian Blundell-Wignall, 2007. "An Overview of Hedge Funds and Structured Products: Issues in Leverage and Risk," Financial Market Trends, OECD Publishing, vol. 2007(1), pages 37-57.
  13. Claudio Borio, 2008. "The financial turmoil of 2007-?: a preliminary assessment and some policy considerations," BIS Working Papers 251, Bank for International Settlements.
  14. Klaus Düllmann & Agnieszka Sosinska, 2007. "Credit default swap prices as risk indicators of listed German banks," Financial Markets and Portfolio Management, Springer, vol. 21(3), pages 269-292, September.
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