Asset Securitization and Optimal Retention

Asset Securitization and Optimal Retention

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This paper builds on recent research by Fender and Mitchell (2009) who show that if financial institutions securitize loans, retaining an interest in the equity tranche does not always induce the securitizer to diligently screen borrowers ex ante. We first determine the conditions under which this scenario becomes binding and further illustrate the implications for capital requirements. We then propose an extension to the existing model and also solve for optimal retention size. This also allows us to capture feedback effects from capital requirements into the maximization problem. Preliminary results show that equity tranche retention continues to best incentivize loan screening.Otherwise, effort level and tranche size are chosen to ensure that the payoff relating to the credit exposure is nona€”negative. We can plot again the implied effort levels according to solution set [26] which is given by the solid blue line and anbsp;...

Title:Asset Securitization and Optimal Retention
Author: John Kiff, Michael Kisser
Publisher:International Monetary Fund - 2010-03-01

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