The Economics of Structured Finance

37 Pages Posted: 22 Oct 2008  

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)

Erik Stafford

Harvard Business School - Finance Unit

Date Written: October 20, 2008

Abstract

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.

Keywords: CDO, Structured Finance, Rating Agency

JEL Classification: G1

Suggested Citation

Coval, Joshua D. and Jurek, Jakub W. and Stafford, Erik, The Economics of Structured Finance (October 20, 2008). Harvard Business School Finance Working Paper No. 09-060. Available at SSRN: https://ssrn.com/abstract=1287363 or http://dx.doi.org/10.2139/ssrn.1287363

Joshua D. Coval

Harvard Business School - Finance Unit ( email )

Boston, MA 02163
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Jakub W. Jurek

University of Pennsylvania - Finance Department ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States
215-898-1588 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Erik Stafford (Contact Author)

Harvard Business School - Finance Unit ( email )

Boston, MA 02163
United States
617-495-8064 (Phone)
617-496-7357 (Fax)

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