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

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

See all articles by Yongheng Deng

Yongheng Deng

Wisconsin School of Business, University of Wisconsin-Madison

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 Bown, 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)

Wisconsin School of Business, University of Wisconsin-Madison ( email )

4110 Grainger Hall
975 University Avenue
Madison, WI 53706
United States
+1 (608) 262-4865 (Phone)

HOME PAGE: http://https://bus.wisc.edu/faculty/yongheng-deng

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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