Subprime borrowers, securitization and the transmission of business cycles

Abstract

A growing literature (e.g., Jaffee et al. 2009, Acharya andSchnabl 2009) argues that securitization improves financial stability if the securitized assets are held by capital market participants, rather than financial intermediaries. I construct a quantitative macroeconomic model with a novel specification for mortgage-backed securities (MBS) to evaluate this claim. My findings suggest that the existence of the securitization market stabilizes the economy under the condition that financial intermediaries do not engage in the acquisition of securitized assets. In the presence of large negative housing preference shocks, the drop in output in the first year after the shock is halved if subprime MBS are purchased by non-financial agents rather than held by banks.

Subprime Mortgages and Banking in a DSGE Model

“…Justiniano et al (2016) introduce subprimer borrowers and distinguish them from primers on the basis of their income level. Grodecka (2016) considers also subprime borrowers in a DSGE model, and does so by distinguishing them from primers by assuming that the latter get fixed rate mortgage contractswhile the former can only get flexible rate mortgage contracts. Our modelling strategy is different and rests on the assumption that subprimers and primers have a different attitude towards defaults, and therefore subprime mortgage contracts are characterized by higher contractual rates.…”