Abstract
This research explores the effects of securitization on the market’s perception of banks’ risk exposure between 2002 and 2007. Our results show that, contrary to some prior evidence in the literature, securitizing banks actually had lower systematic betas until 2007. We find no evidence of increasing idiosyncratic risk with securitization. We identify significant structural break in 2007, when securitizing banks experienced jumps in both systematic and idiosyncratic risks. Finally, we confirm the general belief that larger banks tend to have higher systematic risk and lower idiosyncratic risk because of diversification.
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Notes
Here we distinguish between expected loss and unexpected loss (tail risk). Junior securities in asset securitization absorb most of the expected loss, while investors in senior securities bear some unexpected loss.
It should be noted that different authors use different risk measures. Some studies use accounting risk measures, while we use equity risk measures. One should be cautioned against drawing definitive conclusions from results using different risk measures.
Specifically, if there are two non-negative and positively correlated explanatory variables and the true relation is \( y = {x_1}{\beta_1} + {x_2}{\beta_2} + u \), and if β 2 is positive, then omitting x 2 from the equation could cause the estimate of β 1 to be biased upward.
Schuermann et al. (2006) results show that larger banks have higher market betas than smaller banks.
Another approach is to directly model the bank securitization decision as an endogenous variable and study the impact of securitization with instrument variables. This approach suffers from three major limitations. First, modeling a bank’s securitization decision itself can be complicated, and often results in little model predictive power. Second, choosing the instrument variables often requires a series of assumptions that are hard to test, and the instrument variables often perform poorly. Finally, it is often not the case that a bank’s securitization decision at a given time that affects its risk profile; it is usually the bank’s entire securitization history that produces its current risk profile.
For ease of exposition, we use the same notation for coefficients in both equations although there is no linkage between coefficients in the two equations.
Our decision to measure systematic risk in terms of a bank’s market beta is based on preliminary analysis that the market factor clearly dominates other systematic factors in explaining bank returns. Other macro factors play only a marginal role.
These items are reported in Schedules HC, and HC-B through HC-N, HC-R, and HC-S in the bank holding company database at the Federal Reserve Bank of Chicago.
We exclude Sigma_TB, Sigma_CP, Sigma_Credit, Sigma_Yen, and Sigma_ABS in the final variance regressions because they are highly correlated with Sigma_RM and also highly correlated with each other (pairwise correlations between 0.69 and 0.96).
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Acknowledgments
The authors thank the anonymous reviewer and the editor of this journal, and participants at the 2008 annual conference of the Financial Management Association for helpful comments.
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The views expressed in this paper are those of the authors, and do not necessarily reflect those of the Office of the Comptroller of the Currency.
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Wu, D., Yang, J. & Hong, H. Securitization and Banks’ Equity Risk. J Financ Serv Res 39, 95–117 (2011). https://doi.org/10.1007/s10693-010-0092-5
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DOI: https://doi.org/10.1007/s10693-010-0092-5