Journal of Finance and Economics

Journal of Finance and Economics

ISSN: 2291-4951 (Print)    ISSN: 2291-496X (Online)

Volume 2 (2014), No. 2, Pages 16-53

DOI: 10.12735/jfe.v2i2p16

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Securitization under Asymmetric Information and Risk Retention Requirement

Haejun Jeon1  Michi Nishihara1 

1Graduate School of Economics, Osaka University, Osaka, Japan

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We address a three-period model of financial intermediaries that involves securitization of risky loan assets and asymmetric information. We show that the risk retention requirement with a fixed ratio, stipulated by the Dodd-Frank Act, might induce losses of social welfare in the sense that a bank might not utilize profitable investment opportunities due to the regulation, which leads to a downward jump in social welfare. We present various structures of social welfare with respect to the level of ‘skin in the game’, and clarify the necessity of countercyclical regulation by verifying that the social losses caused by current regulation become more severe during a recession. Furthermore, we verify how the financial market becomes volatile through securitization and leverage.

JEL Classifications: G21, G24, G28

Keywords: securitization, risk retention requirement, skin in the game, asymmetric information, countercyclical regulation

To Cite this Article: Jeon, H., & Nishihara, M. (2014). Securitization under asymmetric information and risk retention requirement. Journal of Finance and Economics, 2(2), 16-53.

Copyright © Haejun Jeon & Michi Nishihara

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This article is published under license to Science and Education Centre of North America. This is an Open Access article distributed under the terms of the Creative Commons Attribution 4.0 International License.

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Securitization under Asymmetric Information and Risk Retention Requirement