Equilibrium Securitization with Diverse Beliefs

50 Pages Posted: 3 Aug 2017 Last revised: 28 Oct 2019

See all articles by Andrew Ellis

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: October 26, 2019

Abstract

We study the effects of diverse beliefs on equilibrium securitization. We provide a simple characterization of the optimal securities. Pooling and tranching of assets emerges in equilibrium as a consequence of traders’ diverse beliefs about asset returns. Under risk neutrality, the issuer of securities tranches the asset pool, and traders sort among the tranches according to their beliefs. We show how the traders’ disagreement about the correlation of asset returns is a key factor in determining which assets are pooled.

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 (October 26, 2019). 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

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