Cheapest-to-Deliver Pricing, Optimal MBS Securitization, and Market Quality

53 Pages Posted: 27 Jul 2020 Last revised: 2 Sep 2022

See all articles by Yesol Huh

Yesol Huh

Board of Governors of the Federal Reserve System

You Suk Kim

Board of Governors of the Federal Reserve System

Multiple version iconThere are 2 versions of this paper

Date Written: September 1, 2022

Abstract

We study optimal securitization and its impact on market quality in the agency mortgage-backed securities (MBS) market. Many MBS are traded in the liquid to-be-announced (TBA) market, which however induces adverse selection due to cheapest-to-deliver pricing. We find that lenders pool high-value loans separately and trade them in a less liquid market. We estimate a structural model of MBS pooling and trading to study welfare implications of pooling policies. Negative externality of strategic pooling on the TBA market results in lower liquidity and welfare in equilibrium. Limiting strategic pooling keeps overall trading costs low but does not benefit high-value loans.

Keywords: Agency Mortgage-Backed Securities, TBA Trades, Securitization, Liquidity

JEL Classification: G21, G10

Suggested Citation

Huh, Yesol and Kim, You Suk, Cheapest-to-Deliver Pricing, Optimal MBS Securitization, and Market Quality (September 1, 2022). Available at SSRN: https://ssrn.com/abstract=3640783 or http://dx.doi.org/10.2139/ssrn.3640783

Yesol Huh (Contact Author)

Board of Governors of the Federal Reserve System ( email )

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HOME PAGE: http://sites.google.com/site/yesolhuh

You Suk Kim

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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