Asymmetric Information and the Death of ABS CDOs

36 Pages Posted: 6 Apr 2013

See all articles by Daniel O. Beltran

Daniel O. Beltran

Federal Reserve Board

Larry Cordell

Federal Reserve Banks - Federal Reserve Bank of Philadelphia

Charles P. Thomas

Thomas & Son Analytics

Date Written: March 2013

Abstract

A key feature of the 2007 financial crisis is that for some classes of securities trade has practically ceased. And where trade has occurred, it appears that market prices are well below their intrinsic values. This seems especially true for those securities where the payoff streams are particularly complex, for example, structured finance ABS CDOs. One explanation for this is that information about these securities' intrinsic values since the crisis has been asymmetric, with current holders having better information than potential buyers. We first characterize the information asymmetries that were present in the structured finance ABS CDO market. Because many of the CDO dealers had partially or fully integrated the pipeline from mortgage originations through CDO issuance, they had informational advantages over potential buyers that could well have disrupted trading in CDOs as the crisis took hold in August of 2007. Using a "workhorse" model for pricing securities under asymmetric information and a novel dataset for the intrinsic values of ABS CDOs, we show how the resulting adverse selection problem could explain why the bulk of these securities either trade at significant discounts to their intrinsic values or do not trade at all.

Keywords: CDO, securitization, asymmetric, lemons

JEL Classification: C63, D82, D43

Suggested Citation

Beltran, Daniel O. and Cordell, Larry and Thomas, Charles P., Asymmetric Information and the Death of ABS CDOs (March 2013). FRB International Finance Discussion Paper No. 1075. Available at SSRN: https://ssrn.com/abstract=2245216 or http://dx.doi.org/10.2139/ssrn.2245216

Daniel O. Beltran (Contact Author)

Federal Reserve Board ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Larry Cordell

Federal Reserve Banks - Federal Reserve Bank of Philadelphia ( email )

Ten Independence Mall
Philadelphia, PA 19106-1574
United States

Charles P. Thomas

Thomas & Son Analytics ( email )

5409 Center St
Chevy Chase, MD 20815
United States
2022075834 (Phone)

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