Cheapest-to-Deliver Pricing, Optimal MBS Securitization, and Welfare Implications
55 Pages Posted: 27 Jul 2020 Last revised: 29 Sep 2023
There are 2 versions of this paper
Cheapest-to-Deliver Pricing, Optimal MBS Securitization, and Welfare Implications
Cheapest-to-Deliver Pricing, Optimal MBS Securitization, and Market Quality
Date Written: May 30, 2023
Abstract
We study optimal securitization in the agency mortgage-backed securities (MBS) market. Many MBS are traded in the liquid to-be-announced (TBA) market, which however induces adverse selection due to cheapest-to-deliver pricing. We find that lenders pool high-value loans separately and trade them in a less liquid market. We estimate a model of MBS pooling and trading to study welfare implications of pooling policies. TBA market structure produces a trade-off between efficiency and equity; broader pooling increases liquidity and average welfare, but results in a larger cross-subsidy from smaller loans to larger loans. Minimizing costs or limiting strategic pooling results in a more regressive redistribution.
Keywords: Agency Mortgage-Backed Securities, TBA Trades, Securitization, Liquidity
JEL Classification: G21, G10
Suggested Citation: Suggested Citation