Bank monitoring incentives and optimal ABS

H. Pag s
Authors registered in the RePEc Author Service: Henri F. Pagès ()

Working papers from Banque de France

Abstract: The paper examines a continuous-time delegated monitoring problem between a competitive investor and an impatient bank monitoring a pool of long-term loans subject to Markovian "contagion." Moral hazard induces a foreclosure bias unless the bank is compensated with the right incentive-compatible contract. Fees are paid when the bank's performance is on target and liquidation arises when the bank's performance is sufficiently poor. I show that the optimal contract can be implemented with a whole loan sale involving both credit risk retention based on ABS credit default swaps and credit enhancement in the form of a reserve account. The optimal securitization bears out rulemaking recently proposed in the wake of the Dodd-Frank Act on a number of controversial provisions. I argue that further efficiency gains could be reaped by extending the role of the "premium capture" account into a liquidity buffer capturing performance-based compensation as a way to increase skin in the game over the life of the deal.

Keywords: ABS Credit Default Swaps; Banking Regulation; Default Correlation; Dynamic Moral Hazard; Optimal Securitization; Risk Retention. (search for similar items in EconPapers)
JEL-codes: G21 G28 G32 (search for similar items in EconPapers)
Pages: 53 pages
Date: 2012
New Economics Papers: this item is included in nep-ban and nep-cta
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Related works:
Journal Article: Bank monitoring incentives and optimal ABS (2013)
Working Paper: Bank incentives and optimal CDOs (2009)
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Persistent link: https://EconPapers.repec.org/RePEc:bfr:banfra:377

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