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Optimal Securitization with Heterogeneous Investors

Author

Listed:
  • Semyon MALAMUD

    (EPFL and Swiss Finance Institute)

  • Huaxia RUIZ

    (University of Texas at Austin)

  • Andrew WHINSTON

    (University of Texas at Austin)

Abstract

We solve the problem of optimal securitization for an issuer facing heteroge- neous investors with arbitrary time and risk preferences. We show that the optimal securitization is characterized by multiple nonlinear tranches, and each investor gets a portfolio of these tranches. In particular, when all agents have CARA util- ities, the linear tranching is optimal, with the number of tranches being less than or equal to the number of investors. To the best of our knowledge, this is the rst model in the literature that explains the appearance of multiple tranches in the security design and the relation of the tranche thresholds to microeconomic characteristics. We show that the boundaries of the tranches can be eciently calculated through a fixed point of a contraction mapping, and we develop new powerful techniques that are generally applicable for numerical calculation of constrained Pareto-efficient allocations. We use these contraction mapping techniques to de- rive a number of comparative static results for optimal securitization. The model generates theoretical predictions and numerical simulations that agree with several recent empirical findings concerning the CDO structure.

Suggested Citation

  • Semyon MALAMUD & Huaxia RUIZ & Andrew WHINSTON, 2010. "Optimal Securitization with Heterogeneous Investors," Swiss Finance Institute Research Paper Series 10-10, Swiss Finance Institute.
  • Handle: RePEc:chf:rpseri:rp1001
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    Keywords

    securitization; tranching; heterogeneity; mortgage backed securities; asset backed securities;

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage

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