Default Risk Sharing between Banks and Markets: The Contribution of Collateralized Debt Obligations
University of Konstanz - Department of Economics
Jan Pieter Krahnen
Faculty of Economics and Business Administration; Goethe University Frankfurt - Research Center SAFE; Center for Financial Studies (CFS); Centre for Economic Policy Research (CEPR)
NBER Working Paper No. w11741
This paper contributes to the economics of financial institutions risk management by exploring how loan securitization affects their default risk, their systematic risk, and their stock prices. In a typical CDO transaction a bank retains through a first loss piece a very high proportion of the default losses, and transfers only the extreme losses to other market participants. The size of the first loss piece is largely driven by the average default probability of the securitized assets. If the bank sells loans in a true sale transaction, it may use the proceeds to expand its loan business, thereby affecting systematic risk. For a sample of European CDO issues, we find an increase of the banks%u2019 betas, but no significant stock price effect around the announcement of a CDO issue.
Number of Pages in PDF File: 39
Date posted: January 22, 2006