Cheapest-to-deliver pricing, optimal MBS securitization, and welfare implications

Yesol Huh and You Suk Kim

Journal of Financial Economics, 2023, vol. 150, issue 1, 68-93

Abstract: We study optimal securitization in the agency mortgage-backed securities (MBS) market. Many MBS are traded in the liquid to-be-announced (TBA) market, which however induces adverse selection due to cheapest-to-deliver pricing. We find that lenders pool high-value loans separately and trade them in a less liquid market. We estimate a model of MBS pooling and trading to study welfare implications of pooling policies. TBA market structure produces a trade-off between efficiency and equity; broader pooling increases liquidity and average welfare, but results in a larger cross-subsidy from smaller loans to larger loans. Minimizing costs or limiting strategic pooling results in a more regressive redistribution.

Keywords: Agency mortgage-backed securities; TBA trades; Securitization; Liquidity (search for similar items in EconPapers)
Date: 2023
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:150:y:2023:i:1:p:68-93

DOI: 10.1016/j.jfineco.2023.07.001

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