Essays on auto loan asset-backed securities: Moral hazard along the securitization chain, and the cross section of expected returns
Loeser, Richard C.
Securitization is the practice of pooling the cashflows of a large number of financial assets and structuring them so as to create a much smaller number of tradable securities. The widespread adoption of securitization as a financing technique has been a major transformative force in the US and global financial systems in recent decades, creating new opportunities for funding and risk sharing. But securitization has also been viewed critically, due to its contributions to the expansion of subprime credit and to the interconnectedness between financial institutions, both of which played important roles for the Financial Crisis that started in 2007. In my thesis, I investigate issues of risk, pricing, and credit ratings of securitized debt in the United States before the Financial Crisis, using a dataset of US asset-backed securities (ABS) of car loans. Auto loans, together with credit card debt, are the most established collateral class for consumer credit securitization, with a volume of $115 billion outstanding at the end of 2015.In the first chapter, I study how prices of auto loan ABS tranches behave over the lifetime of the bonds. Asset-pricing theory posits that expected returns are determined by securities' systematic risk, which can be measured as exposure to risk factors. I employ an interest rate factor as well as different auto loan ABS market factors to study the cross section of expected monthly returns over the period December 1994 to April 2007. In Fama-MacBeth regressions, I find that the interest rate factor is significantly related to expected returns, and in univariate portfolio sorts I find that it generates a risk premium of 5 basis points per month. Furthermore, an auto loan ABS market factor that uses excess returns of lower-rated tranches over AAA-rated ones to measure systematic risk is also priced, with risk premia of 4 to 5 basis points. Finally, I study robustness of the results to the inclusion of time to maturity and credit ratings as alternative measures of risk, and find that exposure to the market factor is robustly priced, while the role of the interest rate factor is taken up by the additional covariates.In the second chapter, I study prime US auto loan ABS issued between 2002 and 2007, and investigate whether deals in which an investment bank securitizes loans acquired in whole-loan sales differ from deals where a lender securitizes collateral they have originated themselves. I argue that moral hazard issues arising from asymmetric information between agents involved in the securitization chain are stronger in deals of whole loans. In line with this view, I show that pool losses are larger in this case, controlling for observable risk characteristics, and conclude that moral hazard is operative in this market. Further, I find that rating agencies were able to recognize the greater risks of whole-loan deals and to adjust their assessments accordingly. Given ratings' important role in securitized debt markets, this implies that prices reflected incentive issues, thus mitigating possible negative effects on macroeconomic outcomes. Finally, I show that for lower-rated tranches, investors priced moral hazard beyond what is contained in ratings.
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