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Briefing

Subprime Mortgages

Appears in: Finance and Banking, Macroeconomy, Markets, Derivatives, Real Estate, Real Estate and Mortgage Finance

Background:

Generally speaking, the less repackaged a security, the higher is the degree of cash-flow pass-through from underlying credits (e.g. pro-rata pass-throughs where each tranche receives the same share of the underlying cash-flow). The further up the repackaging chain, and the more mixed the collateral in a structure, the more the value of a security depends on credit enhancement, leverage, and market risk than on pass-through from underlying credits (see also Adrian/Shin) Moreover, CDOs were overvalued to start with based on their large undiversifiable systemic risk component in senior tranches resulting from cash flow prioritization. This is why current low valuations are more realistic (see Coval et al., Harvard).

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