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Equilibrium Securitization with Diverse Beliefs

46 Pages Posted: 3 Aug 2017 Last revised: 22 Aug 2017

Andrew Ellis

London School of Economics - Department of Economics

Michele Piccione

London School of Economics & Political Science (LSE) - Department of Economics

Shengxing Zhang

London School of Economics (LSE) - Department of Economics

Date Written: August 22, 2017

Abstract

We study a general equilibrium model in which securitization emerges as a consequence of the traders' diverse beliefs about the return of a risky asset. A firm can issue and sell any feasible, monotone securities backed by a risky financial asset to risk neutral traders. Prices and characteristics of securities are determined endogenously in general equilibrium. We provide a simple characterization of the equilibrium securities, and show existence and essential uniqueness of equilibrium. Under a weak restriction on the traders' beliefs, our model delivers tranching as an equilibrium outcome. We extend the model to consider pooling of assets backing the securities, the dynamics of securitization and risk averse traders.

Keywords: securitization, heterogeneous beliefs, collateral, tranching, pooling

JEL Classification: D53; G20

Suggested Citation

Ellis, Andrew and Piccione, Michele and Zhang, Shengxing, Equilibrium Securitization with Diverse Beliefs (August 22, 2017). Available at SSRN: https://ssrn.com/abstract=3011400 or http://dx.doi.org/10.2139/ssrn.3011400

Andrew Ellis

London School of Economics - Department of Economics ( email )

Houghton Street
London WC2A 2AE
United Kingdom

Michele Piccione

London School of Economics & Political Science (LSE) - Department of Economics ( email )

Houghton Street
London WC2A 2AE
United Kingdom

Shengxing Zhang (Contact Author)

London School of Economics (LSE) - Department of Economics ( email )

Houghton Street
London WC2A 2AE
United Kingdom

HOME PAGE: http://https://sites.google.com/site/oo7zsx/

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