Is the Market for Mortgage-Backed Securities a Market for Lemons?

Posted: 22 Jun 2009

See all articles by Chris Downing

Chris Downing

affiliation not provided to SSRN

Dwight M. Jaffee

University of California, Berkeley - Finance Group; National Bureau of Economic Research (NBER)

Nancy Wallace

University of California, Berkeley - Real Estate Group

Date Written: July 2009

Abstract

This paper models and provides empirical evidence for the quality of assets that are securitized through bankruptcy remote special purpose vehicles (SPVs). The model predicts that assets sold to SPVs will be of lower quality (“lemons”) compared to assets that are not sold to SPVs. We find strong empirical support for this prediction using a comprehensive data set of sales of mortgage-backed securities (Freddie Mac Participation Certificates, or PCs) to SPVs over the period 1991 through 2002. Valuation estimates based on a structural two-factor model indicate that PCs sold to SPVs are on average valued $0.39 lower per $100 of face value relative to PCs not so sold. For the four largest coupon groups in our full sample of Freddie Mac PCs, we find a “lemons spread” of 4-6 basis points in terms of yield-to-maturity, and this spread accounts for 13-45% of the overall prepayment spread of these securities.

Keywords: D82, G13, G14, G21

Suggested Citation

Downing, Chris and Jaffee, Dwight M. and Wallace, Nancy E., Is the Market for Mortgage-Backed Securities a Market for Lemons? (July 2009). The Review of Financial Studies, Vol. 22, Issue 7, pp. 2257-2294, 2009. Available at SSRN: https://ssrn.com/abstract=1422413 or http://dx.doi.org/hhn114

Chris Downing (Contact Author)

affiliation not provided to SSRN

No Address Available

Dwight M. Jaffee

University of California, Berkeley - Finance Group ( email )

Haas School of Business
545 Student Services Building
Berkeley, CA 94720
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Nancy E. Wallace

University of California, Berkeley - Real Estate Group ( email )

Berkeley, CA 94720-1900
United States

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