Securitization and Optimal Foreclosure

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John Chi-Fong Kuong

INSEAD - Finance

Jing Zeng

University of Vienna - Department of Finance

Date Written: August 2, 2020

Abstract

Does securitization distort the foreclosure decisions of non-performing mortgages? In a model of mortgage-backed securitization with an endogenous foreclosure policy, we find that the securitizing bank adopts a tougher foreclosure policy than the first-best, despite resulting in higher loan losses. This is optimal because foreclosure mitigates the adverse selection problem in securitization by making the optimal security, a risky debt, less information-sensitive. We further show that policies that limit mortgage foreclosure would discourage the bank's ex ante screening effort, reducing the quality of securitized mortgages. Our model yields novel testable predictions on the effect of mortgage securitization on foreclosure rates, loan performance, and mortgage servicing.

Keywords: Mortgage, securitization, foreclosure, adverse selection, screening

JEL Classification: D8, G21, G23, G24

Suggested Citation

Kuong, John Chi-Fong and Zeng, Jing, Securitization and Optimal Foreclosure (August 2, 2020). Journal of Financial Intermediation, Forthcoming, Available at SSRN: https://ssrn.com/abstract=

John Chi-Fong Kuong

INSEAD - Finance ( email )

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HOME PAGE: http://www.johncfkuong.com

Jing Zeng (Contact Author)

University of Vienna - Department of Finance

oskar-morgenstern-platz 1
Vienna, 1090
Austria

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