Could Regulation of the ABS Secondary Market Improve Social Welfare?

Abstract

This paper examines a model of market making in the ABS market with heterogeneous investors and a lack of price transparency. In this set-up, market makers enjoy market power due to the diversity of assets that back ABS bonds with the same rating: mortgages, credit cards, loans, corporate bonds, etc. It is shown that in a world with no price transparency, allowing free entry of market makers might not be social optimum. Social welfare would be improved by a regulation to restrict the number of market makers in the ABS market to the extent that price competition is guaranteed providing they are forced to buy and sell all possible types of ABS bonds: RMBS, CMBS, CDO, CLO, etc.

Keywords: ABS market, financial regulation, horizontal differentiation

JEL Classification: G15, G18, L81