Abstract

http://ssrn.com/abstract=668264
 
 

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Default Risk Sharing Between Banks and Markets: The Contribution of Collateralized Debt Obligations


Guenter Franke


University of Konstanz - Department of Economics

Jan Pieter Krahnen


University of Frankfurt; Centre for Economic Policy Research (CEPR)

February 15, 2005

CFS Working Paper No. 2005/06

Abstract:     
This paper contributes to the economics of financial institutions risk management by exploring how loan securitization affects their default risk, their systematic risk, and their stock prices. In a typical CDO transaction a bank retains through a first loss piece a very high proportion of the expected default losses, and transfers only the extreme losses to other market participants. The size of the first loss piece is largely driven by the average default probability of the securitized assets. If the bank sells loans in a true sale transaction, it may use the proceeds to to expand its loan business, thereby incurring more systematic risk. We find an increase of the banks' betas, but no significant stock price effect around the announcement of a CDO issue. Our results suggest a role for supervisory requirements in stabilizing the financial system, related to transparency of tranche allocation, and to regulatory treatment of senior tranches.

JEL Classification: D82, G21, D74

working papers series





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Date posted: February 17, 2005  

Suggested Citation

Franke, Guenter and Krahnen, Jan Pieter, Default Risk Sharing Between Banks and Markets: The Contribution of Collateralized Debt Obligations (February 15, 2005). CFS Working Paper No. 2005/06. Available at SSRN: http://ssrn.com/abstract=668264 or http://dx.doi.org/10.2139/ssrn.668264

Contact Information

Guenter Franke
University of Konstanz - Department of Economics ( email )
Fach 147
Konstanz, 78457
Germany
+49 7531 88 2545 (Phone)
+49 7531 88 3559 (Fax)
Jan Pieter Krahnen (Contact Author)
University of Frankfurt ( email )
Grüneburgplatz 1
Frankfurt am Main, 60323
Germany
+49 069 798 22568 (Phone)
+49 069 798 28951 (Fax)
Centre for Economic Policy Research (CEPR)
77 Bastwick Street
London, EC1V 3PZ
United Kingdom
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