Essays on financial intermediation

Abstract

In the first two chapters of the dissertation, I address the research question: why does the issuance of private-label mortgage back securities in the US remain stagnant while all other types of securitization recovered with the economic fundamental years ago? The first chapter presents the static model and the second chapter presents the dynamic model. The third chapter addresses the research question: Why do credit and liquidity conditions vary at the same time and how do they interact along with the business cycle?

I provide a dynamic model of shadow banking and securitization in which short-lived shocks can generate slow recovery. In the model, intermediaries' capital and risk perceptions play key roles in driving securitization dynamics. The model features a self-reinforcing effect between high risk perceptions and low securitization. High risk perceptions reduce intermediaries' willingness to hold junior tranches, leading to low levels of securitization. Since securitization generates a positive informational externality, low issuance slows down learning and risk perception remains high, resulting in very slow recovery. The model can explain why the private label residential mortgage backed securities (PL RMBS) market remains stagnant. During the financial crisis, the massive write-downs of subprime mortgage related securities not only wiped out intermediaries' capital, leading to the collapse of issuance in all major securitization markets but also sharply increased risk perception in PM RMBS market. The higher risk perceptions in PL RMBS market have kept issuance low until now while other securitization markets recovered after intermediaries' recapitalization.

Why do credit and liquidity conditions vary at the same time and how do they interact along with the business cycle? To address these questions, we propose an dynamic equilibrium model where risk-averse banks originate long-term projects and distribute them to risk-neutral investors. The key friction is the information asymmetry between banks and investors. During recession, credit quality deteriorates, making it more costly for banks with good projects to distribute and increasing the severity of information asymmetry.