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Securitization and moral hazard: Does security price matter?(New version)

Liu, Luke (2011): Securitization and moral hazard: Does security price matter?(New version).

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Abstract

This article analyses the effect of security price on the behaviour of bank securitization. We present a model of bank securitization in which security price together with liquid constraints create the incentive for banks to originate and sell assets backed securities to investors. Banks have a comparative advantage in locating and screening projects within their locality. Our results show that under the buyer’s market pricing mechanism the banks with different liquidity constraints can share the risk and the moral hazard problem is not serious; but under the seller’s market pricing mechanism the banks have the incentive to conduct strategic securitization and the moral hazard problem is serious. Our main idea has been supported by the subprime crisis broke in the US in 2007.

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