Ashcraft, Gooriah & Kermani on Mortgage Backed Securities

Adam B. Ashcraft, Kunal Gooriah, and Amir Kermani have posted Does Skin‐in‐the‐Game Affect Security Performance? Evidence from the Conduit CMBS Market on SSRN with the following abstract:

Does reducing the skin‐in‐the‐game of informed agents matter for the performance of securitized assets? In the conduit commercial mortgage backed securities (CMBS) market, an informed investor purchases the bottom five percent of the capital structure, known as the B‐piece, conducting independent screening of loans from which all other investors benefit. However, during the recent credit boom, a secondary market for B‐pieces developed, permitting these investors to significantly reduce their skin‐in‐the‐game. In this paper, we document, that after controlling for all information available at issue, the percentage of the B‐piece that is sold by these investors has a significant adverse impact on the probability that more senior tranches ultimately default. The result is robust to the use of an instrumental variables strategy which relies on the greater ability of larger B‐piece buyers to sell these positions given the need for large pools of collateral. Moreover we show the risk associated with this agency problem was not priced.