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Full-Text Articles in Social and Behavioral Sciences
Tranching, Cds And Asset Prices: How Financial Innovation Can Cause Bubbles And Crashes, Ana Fostel, John Geanakoplos
Tranching, Cds And Asset Prices: How Financial Innovation Can Cause Bubbles And Crashes, Ana Fostel, John Geanakoplos
Cowles Foundation Discussion Papers
We show how the timing of financial innovation might have contributed to the mortgage bubble and then to the crash of 2007-2009. We show why tranching and leverage first raised asset prices and why CDS lowered them afterwards. This may seem puzzling, since it implies that creating a derivative tranche in the securitization whose payoffs are identical to the CDS will raise the underlying asset price while the CDS outside the securitization lowers it. The resolution of the puzzle is that the CDS lowers the value of the underlying asset since it is equivalent to tranching cash.
Tranching, Cds And Asset Prices: How Financial Innovation Can Cause Bubbles And Crashes, Ana Fostel, John Geanakoplos
Tranching, Cds And Asset Prices: How Financial Innovation Can Cause Bubbles And Crashes, Ana Fostel, John Geanakoplos
Cowles Foundation Discussion Papers
We show how the timing of financial innovation might have contributed to the mortgage boom and then to the bust of 2007-2009. We study the effect of leverage, tranching, securitization and CDS on asset prices in a general equilibrium model with collateral. We show why tranching and leverage tend to raise asset prices and why CDS tend to lower them. This may seem puzzling, since it implies that creating a derivative tranche in the securitization whose payoffs are identical to the CDS will raise the underlying asset price while the CDS outside the securitization lowers it. The resolution of the …
Endogenous Leverage: Var And Beyond, Ana Fostel, John Geanakoplos
Endogenous Leverage: Var And Beyond, Ana Fostel, John Geanakoplos
Cowles Foundation Discussion Papers
We study endogenous leverage in a general equilibrium model with incomplete markets. We prove that in any binary tree leverage emerges in equilibrium at the maximum level such that VaR = 0, so there is no default in equilibrium, provided that agents get no utility from holding the collateral. When the collateral does affect utility (as with housing) or when agents have sufficiently heterogenous beliefs over three or more states, VaR = 0 fails to hold in equilibrium. We study commonly used examples: an economy in which investors have heterogenous beliefs and a CAPM economy consisting of investors with different …