Design of Financial Securities: Empirical Evidence from Private-lable RMBS Deals

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Date Published 2013
Primary Author Taylor Begley
Other Authors Amiyatosh Purnanandam
Theme The Secondary Market


Using a representative sample of RMBS deals from the pre-crisis period, we show that deals with a higher level of equity tranche have signi cantly lower foreclosure rates that cannot be explained away by observable credit risk factors of the underlying loan pool. Further, securities that are sold from high-equity-tranche deals command higher prices conditional on their credit ratings. These results show that the equity tranche served as a signal of the unobserved pool quality of these deals. In addition, consistent with theoretical models of pooling and tranching, the level of the AAA-rated tranche is signi cantly higher for pools that bundle loans with commonality in their private information but with uncorrelated risks. Our results highlight the e ectiveness of security design solutions in mitigating informational frictions even during the build-up of the subprime mortgage crisis.

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