Securitization bubbles: Structured finance with disagreement about default risk

Tobias Broer

Journal of Financial Economics, 2018, vol. 127, issue 3, 505-518

Abstract: 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.

Keywords: Structured finance; CDO; RMBS; Disagreement; Default correlation; Credit risk; Great recession; Housing bubble (search for similar items in EconPapers)
JEL-codes: D82 D83 E44 G12 G14 (search for similar items in EconPapers)
Date: 2018
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (9)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:127:y:2018:i:3:p:505-518

DOI: 10.1016/j.jfineco.2017.12.001

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