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Default Risk Sharing Between Banks and Markets: The Contribution of Collateralized Debt Obligations

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Listed author(s):
  • Guenter Franke
  • Jan Pieter Krahnen

Abstract

This paper contributes to the economics of financial institutions risk management by exploring how loan securitization affects their default risk, their systematic risk, and their stock prices. In a typical CDO transaction a bank retains through a first loss piece a very high proportion of the default losses, and transfers only the extreme losses to other market participants. The size of the first loss piece is largely driven by the average default probability of the securitized assets. If the bank sells loans in a true sale transaction, it may use the proceeds to expand its loan business, thereby affecting systematic risk. For a sample of European CDO issues, we find an increase of the banks%u2019 betas, but no significant stock price effect around the announcement of a CDO issue.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 11741.

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Date of creation: Nov 2005
Publication status: published as Carey, Mark, and Rene M. Stulz. A National Bureau of Economic Research Conference Report. Chicago and London: University of Chicago Press, 2006.
Handle: RePEc:nbr:nberwo:11741
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Find related papers by JEL classification:
  • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
  • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
  • D74 - Microeconomics - - Analysis of Collective Decision-Making - - - Conflict; Conflict Resolution; Alliances; Revolutions

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