Correlated Collateral

63 Pages Posted: 22 Mar 2010 Last revised: 16 Jan 2012

See all articles by Taylor Nadauld

Taylor Nadauld

Brigham Young University

Shane M. Sherlund

Federal Reserve Board of Governors

Keith Vorkink

Brigham Young University - J. Willard and Alice S. Marriott School of Management

Date Written: January 17, 2011

Abstract

The prioritized cash flow rules that govern structured finance essentially guarantee that senior tranches will only default in the worst states of the world. In this paper we present empirical evidence which suggests that the impact of economic catastrophe on a structured finance instrument also depends critically on the degree of correlation in the underlying collateral generating the cashflows. Subprime mortgage-backed securities with highly geographically concentrated mortgage collateral (our proxy for correlation) experienced substantially higher deal-level default rates and more significant credit rating downgrades during the financial crisis. Not all deals had geographically concentrated collateral. In fact, we document considerable cross-sectional variation. Collateral concentration did not appear to be priced in the subprime bond market.

Suggested Citation

Nadauld, Taylor and Sherlund, Shane M. and Vorkink, Keith, Correlated Collateral (January 17, 2011). Available at SSRN: https://ssrn.com/abstract=1573042 or http://dx.doi.org/10.2139/ssrn.1573042

Taylor Nadauld (Contact Author)

Brigham Young University ( email )

Provo, UT 84602
United States

Shane M. Sherlund

Federal Reserve Board of Governors ( email )

20th and C Streets, NW
Mailstop 93
Washington, DC 20551
United States
202-452-3589 (Phone)
202-728-5887 (Fax)

Keith Vorkink

Brigham Young University - J. Willard and Alice S. Marriott School of Management ( email )

Provo, UT 84602
United States

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