Privately Versus Publicly Optimal Skin in the Game: Optimal Mechanism and Security Design
Chemla, Gilles; Hennessy, Christopher A. (2011-05), Privately Versus Publicly Optimal Skin in the Game: Optimal Mechanism and Security Design. https://basepub.dauphine.fr/handle/123456789/14130
TypeDocument de travail / Working paper
Series titleCEPR Discussion Paper
MetadataShow full item record
Abstract (EN)We examine screening incentives, welfare and the case for mandatory skin-in-the-game. Ex ante banks can screen, using interim private information to choose retentions and structuring. Ex post speculators trade with rational hedging investors. Absent regulation, there is a separating equilibrium with voluntary retentions. If funding value is high, banks may instead originate-to-distribute (OTD), selling the entire asset in opaque form, deterring informed speculation and destroying screening incentives. Under weaker conditions, banks instead sell the asset in transparent form, using tranching to increase hedging demand, informed speculation and price informativeness. With sufficient informed speculation, transparent OTD actually creates stronger screening incentives than voluntary retentions. In all unregulated market equilibria, interim adverse selection reduces screening incentives, so mandated retentions potentially increase welfare. To induce screening via pooling, banks should be required to retain a uniform junior tranche size which decreases in informational efficiency. However, uniform retention mandates may not be optimal. To improve risk-sharing, screening can instead be induced via separating contracts by compelling banks to choose from a menu of junior tranche retention sizes. In either case, efficiency of risk-sharing is maximized by splitting marketed claims into safe senior and risky mezzanine tranches. Finally, the separating (pooling) regulatory regime generally leads to higher welfare if efficient risk-sharing (bank investment scale) is the dominant consideration, and is always optimal in informationally inefficient markets.
Subjects / KeywordsAdverse selection; Originate to distribute; Screening incentives; Securitization; Skin in the game; Speculator; Uninformed investors
JELD82 - Asymmetric and Private Information; Mechanism Design
G21 - Banks; Depository Institutions; Micro Finance Institutions; Mortgages
G32 - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
G38 - Government Policy and Regulation
L51 - Economics of Regulation
Showing items related by title and author.