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Securitized banking, asymmetric information, and financial crisis: regulating systemic risk away

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  • Bhattacharya, Sudipto
  • Chabakauri, Georgy
  • Nyborg, Kjell

Abstract

We develop a model of securitized (Originate, then Distribute) lending, in which both publicly observed aggregate shocks to values of securitized loan portfolios, and later some asymmetrically observed discernment of varying qualities of subsets thereof, play crucial roles. We find that originators and potential buyers of such assets may differ in their preferences over their timing of trades, leading to a reduction in the aggregate surplus accruing from securitization. In addition, heterogeneity in sellers' selected timing of trades - arising from differences in their ex ante beliefs - coupled with initial leverage choices based on pre-shock prices, may lead to financial crises, implying uncoordinated asset liquidations inconsistent with any inter-temporal market equilibrium. We consider and contrast two mitigating regulatory interventions: leverage restrictions, and ex ante specified resale price guarantees on securitized asset portfolios. We show that the latter tool performs strictly better than the former, by ensuring not only bank survival, but also enhanced social surplus arising from securitized lending. It does so by inducing a more coordinated market equilibrium, that does not lead to interim leverage buildup to support a "cherry picking" seller trading strategy.

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  • Bhattacharya, Sudipto & Chabakauri, Georgy & Nyborg, Kjell, 2012. "Securitized banking, asymmetric information, and financial crisis: regulating systemic risk away," LSE Research Online Documents on Economics 119049, London School of Economics and Political Science, LSE Library.
    • Handle: RePEc:ehl:lserod:119049
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    1. Zhiguo He & Wei Xiong, 2012. "Dynamic Debt Runs," The Review of Financial Studies, Society for Financial Studies, vol. 25(6), pages 1799-1843.
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    More about this item

    JEL classification:

    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • G20 - Financial Economics - - Financial Institutions and Services - - - General

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