The Subprime Panic
Gary B. Gorton
Yale School of Management; National Bureau of Economic Research (NBER)
September 30, 2008
Yale ICF Working Paper No. 08-25
Understanding the ongoing credit crisis or panic requires understanding the designs of a number of interlinked securities, special purpose vehicles, and derivatives, all related to subprime mortgages. I describe the relevant securities, derivatives, and vehicles to show: (1) how the chain of interlinked securities was sensitive to house prices; (2) how asymmetric information was created via complexity; (3) how the risk was spread in an opaque way; and (4) how trade in the ABX indices (linked to subprime bonds) allowed information to be aggregated and revealed. These details are at the heart of the origin of the Panic of 2007. The events of the panic are described.
Number of Pages in PDF File: 40
Keywords: Banking panic, securitization, off-balance sheet vehicles, ABX index
JEL Classification: G1, G2
Date posted: October 1, 2008
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