Securitization and the dark side of diversification
Diversification by banks affects the systemic risk of the sector. Importantly, Wagner (2010) shows that linear diversification increases systemic risk. We consider the case of securitization, whereby loan portfolios are sliced into tranches with different seniority levels. We show that tranching offers nonlinear diversification strategies, which can reduce the failure risk of individual institutions beyond the minimum level attainable by linear diversification, without increasing systemic risk.
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- Wagner, W.B., 2006.
"Diversification at Financial Institutions and Systemic Crises,"
2006-71, Tilburg University, Center for Economic Research.
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"Asset Commonality, Debt Maturity and Systemic Risk,"
10-30, University of Pennsylvania, Wharton School, Weiss Center.
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- Peter DeMarzo & Darrell Duffie, 1999. "A Liquidity-Based Model of Security Design," Econometrica, Econometric Society, vol. 67(1), pages 65-100, January.
- 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.
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