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Securitization bubbles: Structured finance with disagreement about default risk
Stockholm University, Faculty of Social Sciences, Institute for International Economic Studies. Centre for Economic Policy Research, UK.
Number of Authors: 12018 (English)In: Journal of Financial Economics, ISSN 0304-405X, E-ISSN 1879-2774, Vol. 127, no 3, p. 505-518Article in journal (Refereed) Published
Abstract [en]

An additional reason for the structured finance boom of the 2000s may have been disagreement about default risk of collateral assets. When risk-neutral investors disagree about average default probabilities, structuring collateral cash flow raises prices by concentrating optimists' demand on risky tranches. With disagreement about default correlation, low-correlation investors believe in diversification and pay high prices for senior tranches they deem riskless. High-correlation investors value junior tranches they expect to pay whenever aggregate conditions are good. Risk aversion and short selling through credit default swaps reduce the prices of both pass-through and structured securitizations but may increase the return to tranching.

Place, publisher, year, edition, pages
2018. Vol. 127, no 3, p. 505-518
Keywords [en]
Structured finance, CDO, RMBS, Disagreement, Default correlation, Credit risk, Great recession, Housing bubble
National Category
Economics and Business
Identifiers
URN: urn:nbn:se:su:diva-154796DOI: 10.1016/j.jfineco.2017.12.001ISI: 000427335900005OAI: oai:DiVA.org:su-154796DiVA, id: diva2:1198213
Available from: 2018-04-17 Created: 2018-04-17 Last updated: 2018-04-17Bibliographically approved

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