Does Securitization Increase Risk?: A Theory of Loan Securitization, Reputation, and Credit Screening

Posted: 8 Dec 2015 Last revised: 19 May 2016

See all articles by Felipe Cortes

Felipe Cortes

D'Amore-McKim School of Business-Northeastern University

Anjan V. Thakor

Washington University in St. Louis - John M. Olin Business School; Financial Theory Group; European Corporate Governance Institute (ECGI); Massachusetts Institute of Technology (MIT) - Laboratory for Financial Engineering

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

Cortes, Felipe and Thakor, Anjan V., Does Securitization Increase Risk?: A Theory of Loan Securitization, Reputation, and Credit Screening (December 7, 2015). Available at SSRN: https://ssrn.com/abstract=2700179 or http://dx.doi.org/10.2139/ssrn.2700179

Felipe Cortes (Contact Author)

D'Amore-McKim School of Business-Northeastern University ( email )

360 Huntington Ave
419F Hayden Hall
Boston, MA 02140
United States

Anjan V. Thakor

Washington University in St. Louis - John M. Olin Business School ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States

Financial Theory Group ( email )

United States

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

Massachusetts Institute of Technology (MIT) - Laboratory for Financial Engineering ( email )

100 Main Street, E62-618
Cambridge, MA 02142
United States

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