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Optimal Securitization with Moral Hazard

Barney Hartman-Glaser

Duke University - Fuqua School of Business

Tomasz Piskorski

Columbia Business School - Finance and Economics

Alexei Tchistyi

Haas School of Business, UC Berkeley

July 15, 2011

This paper considers the optimal design of mortgage backed securities (MBS) in a dynamic setting with moral hazard. A mortgage underwriter with limited liability can engage in costly effort to screen for low risk borrowers and can sell loans to a secondary market. Secondary market investors cannot observe the effort of the mortgage underwriter, but they can make their payments to the underwriter conditional on the mortgage defaults. We find the optimal contract between the underwriter and the investors involves a single payment to the underwriter after a waiting period. The dynamic setting of our model admits three new findings. First, unlike static models that focus on underwriter retention as a means of providing incentives, our model shows that the timing of payments to the underwriter is the key incentive mechanism. Second, the maturity of the optimal contract can be short even though the mortgages are long-lived. Third, selling pooled mortgages is more efficient than selling mortgages individually because pooling allows investors to learn about the underwriter’s effort more quickly, an information enhancement effect. Our model also allows an evaluation of standard contracts and shows that the “first loss piece” is a very close approximation to the optimal contract.

Number of Pages in PDF File: 46

Keywords: Security design, mortgage backed securities

JEL Classification: G20, G21, G32

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Date posted: April 1, 2009 ; Last revised: August 20, 2011

Suggested Citation

Hartman-Glaser, Barney and Piskorski, Tomasz and Tchistyi, Alexei, Optimal Securitization with Moral Hazard (July 15, 2011). Available at SSRN: http://ssrn.com/abstract=1365000 or http://dx.doi.org/10.2139/ssrn.1365000

Contact Information

Barney Hartman-Glaser (Contact Author)
Duke University - Fuqua School of Business ( email )
Box 90120
Durham, NC 27708-0120
United States
Tomasz Piskorski
Columbia Business School - Finance and Economics ( email )
3022 Broadway
New York, NY 10027
United States

Alexei Tchistyi
Haas School of Business, UC Berkeley ( email )
F602 Haas School of Business
University of California
Berkeley, CA 94720
United States
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