Pooling, tranching, and credit expansion

Spiros Bougheas

Oxford Economic Papers, 2014, vol. 66, issue 2, 557-579

Abstract: Traditionally banks have used securitization for expanding credit and thus their profitability. It has been well documented that, at least before the 2008 crisis, many banks were keeping a high proportion of the securities that they created on their own balance sheets. Those securities retained included both the high-risk ‘equity’ tranche and the low-risk AAA-rated tranche. This article builds a simple model of securitization that accounts for the foregoing retention strategies. Banks in the model retained the equity tranche as skin in the game to mitigate moral hazard concerns whilst they post the low-risk tranche as collateral to take advantage of the yield curve. When variations in loan quality are introduced, the predicted retention strategies match well those found in empirical studies.

Date: 2014
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Working Paper: Pooling, Tranching and Credit Expansion (2012)
Working Paper: Pooling, Tranching and Credit Expansion (2012)
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