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The pricing of subprime mortgage risk in good times and bad: evidence from the ABX.HE indices

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  • Ingo Fender
  • Martin Scheicher

Abstract

This article investigates the pricing of subprime mortgage risk using data for the ABX.HE indices, which have become a key barometer of market conditions during the recent financial crisis. After a discussion of ABX index mechanics and observed pricing patterns, we use regression analysis to establish the relationship between observed index returns and macroeconomic news as well as market-based proxies of various pricing factors. The results imply that declining risk appetite and heightened concerns about market illiquidity-likely due in part to significant short positioning-have provided a sizeable contribution to the observed collapse in ABX prices. In particular, while fundamental factors, such as housing market activity, have continued to exert an important influence on the subordinated indices, those backed by senior exposures have tended to react more to the general deterioration of the financial market environment. This provides further support for the inappropriateness of pricing models that do not account sufficiently for factors such as risk appetite and liquidity risk, particularly in periods of stress. In addition, as related risk premia can be captured by unconstrained investors, these findings lend support to government measures aimed at taking troubled assets off banks' balance sheets (e.g. the Troubled Asset Relief Program).

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  • Ingo Fender & Martin Scheicher, 2009. "The pricing of subprime mortgage risk in good times and bad: evidence from the ABX.HE indices," Applied Financial Economics, Taylor & Francis Journals, vol. 19(24), pages 1925-1945.
    • Handle: RePEc:taf:apfiec:v:19:y:2009:i:24:p:1925-1945
    DOI: 10.1080/09603100903282689
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    Cited by:

    1. Gann, Philipp, 2009. "Liquidität, Risikoeinstellung des Kapitalmarktes und Konjunkturerwartung als Preisdeterminanten von Collateralized Debt Obligations (CDOs) - Eine simulationsgestützte Analyse," Discussion Papers in Business Administration 10582, University of Munich, Munich School of Management.
    2. Contessi, Silvio & De Pace, Pierangelo & Guidolin, Massimo, 2020. "Mildly explosive dynamics in U.S. fixed income markets," European Journal of Operational Research, Elsevier, vol. 287(2), pages 712-724.
    3. Gorton, Gary & Metrick, Andrew, 2012. "Securitized banking and the run on repo," Journal of Financial Economics, Elsevier, vol. 104(3), pages 425-451.
    4. Gorton, Gary & Metrick, Andrew, 2012. "Securitized banking and the run on repo," Journal of Financial Economics, Elsevier, vol. 104(3), pages 425-451.
    5. Aldasoro, Iñaki & Barth, Andreas, 2017. "Syndicated loans and CDS positioning," ESRB Working Paper Series 58, European Systemic Risk Board.
    6. Ingo Fender & Janet Mitchell, 2009. "Incentives and tranche retention in securitisation: a screening model," BIS Working Papers 289, Bank for International Settlements.
    7. J. Mukuddem-Petersen & M. A. Petersen & T. Bosch & B. De Waal, 2011. "Speculative funding and its impact on subprime mortgage product pricing," Applied Financial Economics, Taylor & Francis Journals, vol. 21(19), pages 1397-1408.
    8. Mardi Dungey & Gerald Dwyer & Thomas Flavin, 2013. "Systematic and Liquidity Risk in Subprime-Mortgage Backed Securities," Open Economies Review, Springer, vol. 24(1), pages 5-32, February.
    9. Augustin, Patrick & Subrahmanyam, Marti G. & Tang, Dragon Yongjun & Wang, Sarah Qian, 2014. "Credit Default Swaps: A Survey," Foundations and Trends(R) in Finance, now publishers, vol. 9(1-2), pages 1-196, December.
    10. Ingo Fender & Bernd Hayo & Matthias Neuenkirch, 2011. "Daily CDS pricing in emerging markets before and during the global financial crisis," MAGKS Papers on Economics 201139, Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung).
    11. Alex Dontoh & Fayez A. Elayan & Joshua Ronen & Tavy Ronen, 2021. "Unfair “Fair Value” in Illiquid Markets: Information Spillover Effects in Times of Crisis," Management Science, INFORMS, vol. 67(8), pages 5163-5193, August.
    12. Fender, Ingo & Hayo, Bernd & Neuenkirch, Matthias, 2012. "Daily pricing of emerging market sovereign CDS before and during the global financial crisis," Journal of Banking & Finance, Elsevier, vol. 36(10), pages 2786-2794.
    13. Leung, W.S. & Taylor, N. & Evans, K.P., 2015. "The determinants of bank risks: Evidence from the recent financial crisis," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 34(C), pages 277-293.
    14. Roberts, John & Wang, Timothy, 2019. "Faithful representation as an ‘objective mirage’: A Saussurean analysis of accounting and its participation in the financial crisis," CRITICAL PERSPECTIVES ON ACCOUNTING, Elsevier, vol. 65(C).
    15. Woon Sau Leung & Nicholas Taylor, 2013. "Testing for contagion: the impact of US structured markets on international financial markets," Chapters, in: Adrian R. Bell & Chris Brooks & Marcel Prokopczuk (ed.), Handbook of Research Methods and Applications in Empirical Finance, chapter 11, pages 256-284, Edward Elgar Publishing.

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