Optimal incentives and securitization of defaultable assets

Semyon Malamud, Huaxia Rui and Andrew Whinston

Journal of Financial Economics, 2013, vol. 107, issue 1, 111-135

Abstract: We study optimal securitization in the presence of an initial moral hazard. A financial intermediary creates and then sells to outside investors defaultable assets, whose default risk is determined by the unobservable costly effort exerted by the intermediary. We calculate the optimal contract for any given effort level and show the natural emergence of extreme punishment for defaults, under which investors stop paying the intermediary after the first default. With securitization contracts optimally designed, we find securitization improves the intermediary's screening incentives. Furthermore, the equilibrium effort level and the surplus converge to their first best levels with sufficiently many assets.

Keywords: Securitization; Mortgage-backed securities; Asset-backed securities; Moral hazard; Default risk (search for similar items in EconPapers)
JEL-codes: D8 G21 G24 G32 (search for similar items in EconPapers)
Date: 2013
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (14)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:107:y:2013:i:1:p:111-135

DOI: 10.1016/j.jfineco.2012.08.001

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