Saturday, October 6, 2012: 9:40 AM
A key feature of the 2007-2008 financial crisis is that for some classes of securities trade has practically ceased. And where trade does occur, it
appears that market prices are well below what one might believe to be the intrinsic value for that class of security. This seems to be especially true
for those securities where the payoff streams are particularly complex (for example, structured finance ABS CDOs). One explanation for this is that information about these
securities' intrinsic values is asymmetric, with current holders having better information than potential buyers. We first characterize the information asymmetries that are present
in the structured finance ABS CDO market. Then, using a ``workhorse'' model for pricing securities under asymmetric information and a data on the distribution of intrinsic values of ABS CDOs, we show how the resulting adverse selection problem can help explain why the bulk of these CDOs either trade at significant discounts to their intrinsic values or do not trade at all.
appears that market prices are well below what one might believe to be the intrinsic value for that class of security. This seems to be especially true
for those securities where the payoff streams are particularly complex (for example, structured finance ABS CDOs). One explanation for this is that information about these
securities' intrinsic values is asymmetric, with current holders having better information than potential buyers. We first characterize the information asymmetries that are present
in the structured finance ABS CDO market. Then, using a ``workhorse'' model for pricing securities under asymmetric information and a data on the distribution of intrinsic values of ABS CDOs, we show how the resulting adverse selection problem can help explain why the bulk of these CDOs either trade at significant discounts to their intrinsic values or do not trade at all.