Securitization and Asset Prices∗

During the 15 years prior to the global financial crisis the volume of securitized assets transacted in the US has grown substantially, reflecting a change in the nature of the financial intermediation process. Together with increased securitization, financial entities, who participate more heavily in the asset-backed security (ABS) market and hold a diversified portfolio of assets, have also become more relevant. As a result, the volume of securitization, although traditionally associated with credit markets, influences the outcomes of other asset markets. We investigate the link between securitization and asset prices and show that increases in the growth rate of the volume of ABS issuance lead to a decline in both the bond and equity premia. We then build a model of bank portfolio choice where the creation of synthetic securities may occur. The pooling and tranching of credit assets relaxes both the funding and the risk constraints financial entities face allowing them to increase balance sheet holdings. This increase in asset demand depresses the compensation for undertaking risk in the economy, confirming our empirical results. We show that financial intermediation is linked with asset prices through this portfolio mechanism, whose strength depends on the volume of deals in the securitization market. JEL Codes: E44, G12, G2 Keyword: Pooling and Tranching, Equity, Government Bonds, Bank Portfolio, Risk Premia ∗We would like to thank, without implicating, Georgy Chabakauri (our discussant), Pavol Povala, Ron P. Smith, seminar participants at the City University London, University of St Andrews, University of Glasgow, participants at the CESIfo Area Conference on Macro, Money and International Finance 2014 in Munich, BCAM conference at Birkbeck, BMRC-DEMS Conference at Brunel university, MMF Conference in Durham, CEF 2014 conference in Oslo and LAMES 2014 in Sao Paulo for helpful comments. The views expressed in this paper are those of the authors and do not necessarily coincide with those of the Banco de España and the Eurosystem. Yunus Aksoy and Henrique S. Basso are also affiliated with the Birkbeck Centre for Applied Macroeconomics (BCAM). †Department of Economics, Mathematics and Statistics, Birkbeck, University of London, Malet Street, WC1E 7HX, London, United Kingdom, Tel: +44 20 7631 6407, Fax: +44 20 7631 6416, e-mail: [email protected] ‡Banco de España, Research Department, Alcalá 48, 28014 Madrid, Spain e-mail: [email protected]