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

Taylor A. Begley, Amiyatosh K. Purnanandam
2012 Social Science Research Network  
Using a representative sample of Residential Mortgage-Backed Securities (RMBS), we show that deal sponsors use the equity tranche as a signal of the unobserved quality of opaque pools. Deals with higher level of equity tranche have significantly lower foreclosure rates that cannot be explained away by observable credit risk or correlation structure of the loans in the underlying pool. Further, we analyze trade-offs that are unique to bundling and tranching of loans in securitization deals as
more » ... pared to the sale of a single asset. Consistent with DeMarzo's (2005) model, we show that the extent of AAA-rated tranche is significantly higher for pools that bundle loans with commonality in their private information but with uncorrelated risks. Overall, we uncover some of the key economic drivers of RMBS design and document contracting frictions that the design was able to mitigate even during the peak of the subprime mortgage market.
doi:10.2139/ssrn.2022380 fatcat:6yofmlrvknahfinhez3rgatdue