CDO Market Implosion and the Pricing of Subprime Mortgage-Backed Securities

42 Pages Posted: 11 Mar 2009 Last revised: 7 Sep 2010

Yongheng Deng

National University of Singapore, Business School and the School of Design and Environment; National University of Singapore (NUS) - Department of Real Estate

Stuart A. Gabriel

University of California, Los Angeles - Anderson School of Management

Anthony B. Sanders

George Mason University - School of Business

Date Written: March 1, 2009

Abstract

We evaluate the effects of CDO issuance on the pricing of subprime mortgage-backed securities. Upon controlling for mortgage option values and other well-established determinants of credit spreads, GMM results indicate that the emergence and rapid capitalization of the subprime-backed CDO market was associated with a significant tightening of subprime MBS/Treasury yield spreads. Results of VAR and other robustness tests serve to corroborate the findings. Dynamic simulation based on the impulse response functions shows substantial subprime MBS spread widening in the wake of implosion in the CDO market. Those effects likely were passed back to the primary market in the form of diminished investor demand and related reduced pricing of subprime loans. Research findings also suggest the importance of supply/demand shocks associated with innovations in derivative securities markets to the pricing of securitized subprime debt.

Keywords: collateralized debt obligations, subprime crisis, yield spreads on mortgage-backed securities

JEL Classification: R31, G10, G12, G01

Suggested Citation

Deng, Yongheng and Gabriel, Stuart A. and Sanders, Anthony B., CDO Market Implosion and the Pricing of Subprime Mortgage-Backed Securities (March 1, 2009). Available at SSRN: https://ssrn.com/abstract=1356630 or http://dx.doi.org/10.2139/ssrn.1356630

Yongheng Deng (Contact Author)

National University of Singapore, Business School and the School of Design and Environment ( email )

4 Architecture Drive
Singapore 117566
Singapore
(65) 6516 8291 (Phone)
(65) 6774 1003 (Fax)

HOME PAGE: http://www.ires.nus.edu.sg

National University of Singapore (NUS) - Department of Real Estate ( email )

4 Architecture Drive
Singapore 117566
Singapore
(65) 6516 8291 (Phone)
(65) 6774 1003 (Fax)

HOME PAGE: http://www.ires.nus.edu.sg

Stuart A. Gabriel

University of California, Los Angeles - Anderson School of Management ( email )

110 Westwood Plaza
Los Angeles, CA 90095-1481
United States
310-825-2922 (Phone)
310-206-5455 (Fax)

HOME PAGE: http://www.anderson.ucla.edu

Anthony Bown Sanders

George Mason University - School of Business ( email )

Fairfax, VA 22030
United States

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