Does Skin‐in‐the‐Game Affect Security Performance?

60 Pages Posted: 17 Jul 2014 Last revised: 16 May 2018

Adam B. Ashcraft

Federal Reserve Bank of New York

Kunal Gooriah

Federal Reserve Banks - Federal Reserve Bank of New York

Amir Kermani

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

Date Written: March 1, 2017

Abstract

This paper documents that the rise of complex financial innovations like CDOs enabled informed parties in the commercial mortgage backed securitization pipeline to reduce their skin-in-the-game in a way that was not observable to other market participants. This reduction in the amount of first-loss security retention had a significant impact on the probability that more senior tranches ultimately defaulted, after controlling for information available at issue including the market price. We show that this lower performance is entirely driven by the amount of first-loss sold to (affiliated) CDOs within 12 months from the origination of the CMBS deal. Our result is robust to using the differential access of first-loss investors to CDO funding as an instrument to identify plausibly exogenous variations in the retention of first-loss securities.

Keywords: skin-in-the-game, securitization, secondary market, commercial mortgage backed securities

JEL Classification: D82 , G21, G23

Suggested Citation

Ashcraft, Adam B. and Gooriah, Kunal and Kermani, Amir, Does Skin‐in‐the‐Game Affect Security Performance? (March 1, 2017). Available at SSRN: https://ssrn.com/abstract=2437574 or http://dx.doi.org/10.2139/ssrn.2437574

Adam B. Ashcraft

Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045-0001
United States
212-720-1617 (Phone)
212-720-8363 (Fax)

Kunal Gooriah

Federal Reserve Banks - Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States

Amir Kermani (Contact Author)

University of California, Berkeley ( email )

2220 Piedmont Ave
Berkeley, CA 94720
United States

HOME PAGE: http://faculty.haas.berkeley.edu/amir/research/research.html

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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