Skin in the Game and Moral Hazard

What determines securitization levels, and should they be regulated? To address these questions we develop a model where originators can exert unobservable effort to increase expected asset quality, subsequently having private information regarding quality when selling ABS to rational investors. Abs...

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Bibliographic Details
Published in:The Journal of finance (New York) 2014-08, Vol.69 (4), p.1597-1641
Main Authors: CHEMLA, GILLES, HENNESSY, CHRISTOPHER A.
Format: Article
Language:English
Subjects:
Cash flow
Economic incentives
Endowments
Financial securities
Game theory
Information
Investors
Market equilibrium
Moral hazard
Opacity
Prices
Regulation
Return on investment
Sales management
Securitization
Speculators
Studies
Value
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Summary:What determines securitization levels, and should they be regulated? To address these questions we develop a model where originators can exert unobservable effort to increase expected asset quality, subsequently having private information regarding quality when selling ABS to rational investors. Absent regulation, originators may signal positive information via junior retentions or commonly adopt low retentions if funding value and price informativeness are high. Effort incentives are below first-best absent regulation. Optimal regulation promoting originator effort entails a menu of junior retentions or one junior retention with size decreasing in price informativeness. Zero retentions and opacity are optimal among regulations inducing zero effort.
ISSN:0022-1082
1540-6261
DOI:10.1111/jofi.12161