Chapter

Default Risk Sharing between Banks and Markets: The Contribution of Collateralized Debt Obligations

Günter Franke and Jan Pieter Krahnen

in The Risks of Financial Institutions

Published by University of Chicago Press

Published in print February 2007 | ISBN: 9780226092850
Published online February 2013 | e-ISBN: 9780226092980 | DOI: http://dx.doi.org/10.7208/chicago/9780226092980.003.0014
Default Risk Sharing between Banks and Markets: The Contribution of Collateralized Debt Obligations

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This chapter presents evidence that European securitizations increase the systematic risk exposure of sponsoring banks. The default losses of the securitized portfolio largely remain on the books of the issuing bank. The risk of extreme unexpected losses is transferred from the bank to investors. The net impact of securitization on the bank's stock price is hard to predict. Many banks engaged in securitizations increase their exposure vis-à-vis the market return. The beta increase after securitizations is much stronger for repeat issuers. Thus, many banks use the risk reduction achieved through securitization to take new risks. The risk transfer obtained by securitization depends as much on the way the issue is tranched as on the allocation of these tranches to different groups of investors. Financial stability would be enhanced if banks would neither invest in the senior tranches nor retain them, but sell them to more remote investors.

Keywords: systematic risk exposure; European securitizations; sponsoring banks; stock price; risk reduction; investors; senior tranches

Chapter.  13887 words.  Illustrated.

Subjects: Financial Markets

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