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

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  • Huh, Yesol
  • Kim, You Suk

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.

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  • Huh, Yesol & Kim, You Suk, 2023. "Cheapest-to-deliver pricing, optimal MBS securitization, and welfare implications," Journal of Financial Economics, Elsevier, vol. 150(1), pages 68-93.
    • Handle: RePEc:eee:jfinec:v:150:y:2023:i:1:p:68-93
    DOI: 10.1016/j.jfineco.2023.07.001
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