Does Securitization Increase Risk?: A Theory of Loan Securitization, Reputation, and Credit Screening
Posted: 8 Dec 2015 Last revised: 19 May 2016
Date Written: December 7, 2015
Abstract
How does securitization affect the risk of the loans that are originated for securitization? While the standard view is that the originate-to-distribute (OTD) model weakens the originator's screening incentives and leads to higher risk, theories on reputation suggest that an originator's concern about its ability to return to the market would prevent lax screening. In a model with reputational concerns, OTD model of securitization and pooling of loans, we analyze how loan securitization dilutes reputation-driven incentives to screen. With sufficiently strong reputational concerns there may be an overinvestment in screening even relative to the no-securitization case, so the OTD model does not suffice for securitization to increase risk. However, when multiple loans are pooled together and securitized, reputational incentives to screen become weaker with an increase in the size of the loan pool being securitized. Moreover, there is a mutually reinforcing feedback effect between the originator's screening incentives and the incentives of investors to acquire information about the quality of the loan pool, so investors are also less informed about larger loan pools. For sufficiently large loan pools, securitization reduces idiosyncratic risk but increases systematic risk.
Keywords: Career Concerns, Pooling, Screening, Securitization, Systematic Risk
JEL Classification: G2
Suggested Citation: Suggested Citation