Systemic Risk and Market Institutions

15 Pages Posted: 27 Aug 2009

See all articles by Andrey D. Pavlov

Andrey D. Pavlov

Simon Fraser University (SFU) - Finance Area

Susan M. Wachter

University of Pennsylvania - Wharton School, Department of Real Estate ; University of Pennsylvania - Finance Department

Date Written: 2009

Abstract

With private-label mortgage-backed securities (MBS), investors bore default risk; while this risk should have been priced, as systemic risk grew, the pricing of risk did not increase. This paper attempts to explain why this happened. We point to market institutions’ incentive misalignments that cause asset prices to rise above fundamentals, producing systemic risk. The model attributes the asset price inflation to the provision of underpriced credit as lending institutions misprice risk to gain market share. The resulting asset price inflation itself then generates further expansion of underpriced credit.

Keywords: Real estate, mortgages, housing, mortgage-backed securities, pricing of risks, default risk, incentive misalignments, underpriced credit, asset price inflation, market bubbles

JEL Classification: G21, K22

Suggested Citation

Pavlov, Andrey D. and Wachter, Susan M., Systemic Risk and Market Institutions (2009). Yale Journal on Regulation, Vol. 26, No. 2, 2009; University of Pennsylvania, Institute for Law & Economics Research Paper No. 09-26. Available at SSRN: https://ssrn.com/abstract=1462360

Andrey D. Pavlov

Simon Fraser University (SFU) - Finance Area ( email )

Burnaby, British Columbia V5A 1S6
Canada
604 291 5835 (Phone)
604 291 4920 (Fax)

Susan M. Wachter (Contact Author)

University of Pennsylvania - Wharton School, Department of Real Estate ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104-6330
United States
215-898-6355 (Phone)

HOME PAGE: http://real.wharton.upenn.edu/~wachter/index.html

University of Pennsylvania - Finance Department ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States

HOME PAGE: http://real.wharton.upenn.edu/~wachter/index.html

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