Complexity in Structured Finance

57 Pages Posted: 15 Sep 2013 Last revised: 13 May 2017

Andra C. Ghent

University of Wisconsin - School of Business - Department of Real Estate and Urban Land Economics

Walter N. Torous

Massachusetts Institute of Technology

Rossen I. Valkanov

University of California, San Diego (UCSD) - Rady School of Management

Date Written: April 26, 2017

Abstract

We study complexity in the market for securitized products, a market in which it is easy for buyers to observe prices but difficult to observe product quality. We find that securities in more complex residential MBS deals default more and have lower IRRs. The higher likelihood of default is economically meaningful: a one standard deviation increase in complexity represents an 18\% increase in default on AAA securities. However, yields of more complex securities are not higher indicating that investors do not perceive them as riskier. A channel by which complexity affects security default is the diversion of collateral cash from higher-rated to residual tranches.

Keywords: Complexity, Security Design, MBS Performance

JEL Classification: G12, G14, G21, G24

Suggested Citation

Ghent, Andra C. and Torous, Walter N. and Valkanov, Rossen I., Complexity in Structured Finance (April 26, 2017). Available at SSRN: https://ssrn.com/abstract=2325835 or http://dx.doi.org/10.2139/ssrn.2325835

Andra C. Ghent (Contact Author)

University of Wisconsin - School of Business - Department of Real Estate and Urban Land Economics ( email )

School of Business
975 University Avenue
Madison, WI 53706
United States

Walter N. Torous

Massachusetts Institute of Technology ( email )

Center for Real Estate and Sloan School
Cambridge, MA 02138
United States

Rossen Valkanov

University of California, San Diego (UCSD) - Rady School of Management ( email )

9500 Gilman Drive
Rady School of Management
La Jolla, CA 92093
United States
858-534-0898 (Phone)

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