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Skin in the Game and Moral Hazard

Author

Listed:
  • Gilles Chemla

    (DRM - Dauphine Recherches en Management - Université Paris Dauphine-PSL - PSL - Université Paris Sciences et Lettres - CNRS - Centre National de la Recherche Scientifique)

  • Christopher A. Hennessy

    (London Business School - London Business School)

Abstract

What determines equilibrium securitization levels, and should they be regulated? To address these questions we develop a model where originators can exert unobservable effort to increase asset quality, subsequently having private information regarding quality when selling ABS to rational investors. In equilibrium, all originators have low/zero retentions if they are financially constrained and/or prices are su¢ ciently informative. Asymmetric information lowers effort incentives in all equilibria. Effort is promoted by junior retentions, investor sophistication, andinformative prices. Optimal regulation promotes effort while accounting for investor-level externalities. It entails either a menu of junior retentions or a single junior retention with sizedecreasing in price informativeness. Mandated market opacity is only optimal amongst regulations failing to induce originator effort.

Suggested Citation

  • Gilles Chemla & Christopher A. Hennessy, 2014. "Skin in the Game and Moral Hazard," Post-Print hal-01457063, HAL.
    • Handle: RePEc:hal:journl:hal-01457063
    DOI: 10.1111/jofi.12161
    Note: View the original document on HAL open archive server: https://hal.science/hal-01457063
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    References listed on IDEAS

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