Complexity in Structured Finance: Financial Wizardry or Smoke and Mirrors?
Andra C. Ghent
University of Wisconsin - School of Business - Department of Real Estate and Urban Land Economics
Walter N. Torous
University of California, Los Angeles (UCLA) - Finance Area
Rossen I. Valkanov
University of California, San Diego (UCSD) - Rady School of Management
August 9, 2014
We use data from prospectus supplements to measure the complexity of securitized products. We find that securities in more complex deals default more. The higher likelihood of default is economically meaningful: a one standard deviation increase in complexity represents a 17\% increase in default on AAA securities. However, yields of more complex securities are not higher indicating that investors do not perceive them as riskier. The relation between complexity and default is not primarily due to issuers masking low quality loans as it persists after controlling for the collateral default rate. Rating agencies are more lenient in rating complex deals.
Number of Pages in PDF File: 54
Keywords: Complexity, Security Design, MBS Performance
JEL Classification: G12, G14, G21, G24
Date posted: September 15, 2013 ; Last revised: June 1, 2015
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