The Pooling and Tranching of Securities: A Model of Informed Intermediation

I show that when an issuer has superior information about the value of its assets, it is better off selling assets separately rather than as a pool due to the information destruction effect of pooling. If, however, the issuer can create a derivative security that is collateralized by the assets, poo...

Full description

Saved in:
Bibliographic Details
Published in:The Review of financial studies 2005-04, Vol.18 (1), p.1-35
Main Author: DeMarzo, Peter M.
Format: Article
Language:English
Subjects:
Adverse selection
Asset backed securities
Asset management
Asset valuation
Assets
Bond issues
Cash
Cash flow
Collateralized bond obligations
Collateralized mortgage obligations
Cost-effectiveness
Debt
Diversifiable risk
Diversification
Finance
Financial economics
Financial securities
Information
Information asymmetry
Information intermediaries
Investment pools
Investors
Mortgage backed securities
Resale
Risk
Risk management
Securities issues
Securities markets
Securitization
Stock prices
Studies
Citations: Items that this one cites
Items that cite this one
Online Access:Get full text
Tags: Add Tag
No Tags, Be the first to tag this record!
Description
Summary:I show that when an issuer has superior information about the value of its assets, it is better off selling assets separately rather than as a pool due to the information destruction effect of pooling. If, however, the issuer can create a derivative security that is collateralized by the assets, pooling and "tranching" may be optimal. If the residual risk of each asset is not highly correlated, tranching allows the issuer to exploit the risk diversification effect of pooling to create a low-risk and highly liquid security. In contrast, for an uninformed seller, pure pooling reduces underpricing and is preferred to separate asset sales. These results lead to a dynamic model of financial intermediation: originators sell pools of assets, some of which are purchased by informed intermediaries who then further pool and tranche them. Pooling and tranching allow intermediaries to leverage their capital more efficiently, enhancing the returns to their private information.
ISSN:0893-9454
1465-7368
DOI:10.1093/rfs/hhi008