The Design and Risk Management of Structured Finance Vehicles

30 Pages Posted: 1 Nov 2014 Last revised: 27 Jul 2016

Sanjiv Ranjan Das

Santa Clara University - Leavey School of Business

Seoyoung Kim

Santa Clara University

Date Written: July 6, 2016

Abstract

Special purpose vehicles (SPVs), extremely popular financial structures for the creation of highly-rated tranched securities, experienced spectacular demise in the 2007-08 financial crisis. These financial vehicles epitomize the shadow banking sector, characterized by high leverage, undiversified asset pools, and long-dated assets supported by short-term debt, thus bearing material rollover risk on their liabilities which led to defeasance. This paper models these vehicles, and shows that imposing leverage risk control triggers can be optimal for all capital providers. The efficacy of these risk controls vary depending on anticipated asset volatility and fire-sale discounts on defeasance. Despite risk management controls, we show that a high failure rate is inherent in the design of these vehicles, and may be mitigated to some extent by including contingent capital provisions in the ex-ante covenants. Post the recent subprime financial crisis, we inform the creation of safer SPVs in structured finance, and propose avenues of mitigating risks faced by senior debt through deleveraging policies in the form of leverage risk controls and contingent capital.

Keywords: SPVs; SIVs; special purpose vehicle; structured investment vehicle; structured finance risk controls; structured finance credit ratings; contingent capital

JEL Classification: G00; G2

Suggested Citation

Das, Sanjiv Ranjan and Kim, Seoyoung, The Design and Risk Management of Structured Finance Vehicles (July 6, 2016). Available at SSRN: https://ssrn.com/abstract=2517112 or http://dx.doi.org/10.2139/ssrn.2517112

Sanjiv Ranjan Das

Santa Clara University - Leavey School of Business ( email )

Department of Finance
316M Lucas Hall
Santa Clara, CA 95053
United States

HOME PAGE: http://algo.scu.edu/~sanjivdas/

Seoyoung Kim (Contact Author)

Santa Clara University ( email )

500 El Camino Real
Santa Clara, CA California 95053
United States

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