The Economics of Structured Finance
Joshua D. Coval
Harvard Business School - Finance Unit; National Bureau of Economic Research (NBER)
Jakub W. Jurek
University of Pennsylvania - Finance Department; National Bureau of Economic Research (NBER)
Harvard Business School - Finance Unit
October 20, 2008
Harvard Business School Finance Working Paper No. 09-060
The essence of structured finance activities is the pooling of economic assets (e.g. loans, bonds, mortgages) and subsequent issuance of a prioritized capital structure of claims, known as tranches, against these collateral pools. As a result of the prioritization scheme used in structuring claims, many of the manufactured tranches are far safer than the average asset in the underlying pool. We examine how the process of securitization allowed trillions of dollars of risky assets to be transformed into securities that were widely considered to be safe, and argue that two key features of the structured finance machinery fueled its spectacular growth. At the core of the recent financial market crisis has been the discovery that these securities are actually far riskier than originally advertised.
Number of Pages in PDF File: 37
Keywords: CDO, Structured Finance, Rating Agency
JEL Classification: G1
Date posted: October 22, 2008
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