The Journal of Risk Finance

Buchanan, Bonnie

2014 The Journal of Risk Finance

doi: 10.1108/JRF-04-2014-0040

Purpose– Before the 2007 financial crisis, securitized products accounted for half the credit market. Once regarded as one of the biggest financial innovations of the last century, securitization is now viewed as a contributory factor to the crisis. Until recently research has focused on the post-1970s mortgage securitization market. In this paper, I trace the earlier origins of securitization, from the 12th century Genoese compera through to early 20th century efforts. The historical examples highlight unifying themes on risk allocation and complexity. As the future securitization market remains uncertain, it is important to consider lessons to be learned from these historical episodes. Design/methodology/approach– This is primarily a survey article that utilizes historical documents to compare/contrast features of securitization with the recent crisis. Findings– Improved disclosure is the key element to address recent securitization flaws, but disclosure does not really matter if the entire process is not understood. An examination of historical episodes can be instructive. Forging ahead, any securitization reform needs to address why securitization markets formed, why they failed and how the securitization market can be improved. Practical implications– As the future securitization market remains uncertain, it is important to consider lessons to be learned from these historical episodes. Originality/value– To the best of my knowledge, this is one of the first research papers that surveys the history of securitization as far back as the twelfth century.

R. Mason, Joseph; B. Imerman, Michael; Lee, Hong

2014 The Journal of Risk Finance

doi: 10.1108/JRF-05-2014-0069

Purpose– The purpose of this paper is to illustrate the limitations and potential bias in securitized residential mortgage data and examine the importance of such data issues for typical studies of residential mortgage-backed security (RMBS) market and the financial crisis. Design/methodology/approach– We use trustee data on mortgage characteristics provided by BlackBox Logic – the BBx data – to study the extent to which undisclosed mortgage characteristics distort the available data and impact risk analysis of RMBS collateral pools. Findings– We illustrate that substantial amounts of loan characteristic data in crucial fields like occupancy, property type, loan purpose and FICO are missing from the trustee data. The frequency of missing values is staggering, ranging from just under 9 per cent for property type to 29 per cent for FICO, up to almost 85 per cent for originator name, all variables used in recent studies. The omissions are correlated to some degree with the securitization sponsor and even more dramatically with the identity of the deal trustee. Research limitations/implications– Analysis of RMBS collateral should be built not on the entirety of mortgage databases, but on stratified samples and should otherwise control for important sponsor and trustee fixed effects. Practical implications– The revisions for Regulation AB which require loan-level disclosure should be adopted to standardize mortgage disclosure. Originality/value– This is the first paper that examines selection bias in loan characteristics relied upon for a wide variety of mortgage market research that has substantially affected policy decisions in the post-crisis era.

Lorson, Jonas; Wagner, Joël

2014 The Journal of Risk Finance

doi: 10.1108/JRF-02-2014-0016

Purpose– The purpose of this paper is to develop a model to hedge annuity portfolios against increases in life expectancy. Across the globe, and in the industrial nations in particular, people have seen an unprecedented increase in their life expectancy over the past decades. The benefits of this apply to the individual, but the dangers apply to annuity providers. Insurance companies often possess no effective tools to address the longevity risk inherent in their annuity portfolio. Securitization can serve as a substitute for classic reinsurance, as it also transfers risk to third parties. Design/methodology/approach– This paper extends on methods insurer's can use to hedge their annuity portfolio against longevity risk with the help of annuity securitization. Future mortality rates with the Lee-Carter-model and use the Wang-transformation to incorporate insurance risk are forecasted. Based on the percentile tranching method, where individual tranches are aligned to Standard & Poor's ratings, we price an inverse survivor bond. This bond offers fix coupon payments to investors, while the principal payments are at risk and depend on the survival rate within the underlying portfolio. Findings– The contribution to the academic literature is threefold. On the theoretical side, building on the work of Kim and Choi (2011), we adapt their pricing model to the current market situation. Putting the principal at risk instead of the coupon payments, the insurer is supplied with sufficient capital to cover additional costs due to longevity. On the empirical side, the method for the German market is specified. Inserting specific country data into the model, price sensitivities of the presented securitization model are analyzed. Finally, in a case study, the procedure to the annuity portfolio of a large German life insurer is applied and the price of hedging longevity risk is calculated. Practical implications– To illustrate the implication of this bond structure, several sensitivity tests were conducted before applying the pricing model to the retail sample annuity portfolio from a leading German life insurer. The securitization structure was applied to calculate the securitization prices for a sample portfolio from a large life insurance company. Social implications– The findings contribute to the current discussion about how insurers can face longevity risk within their annuity portfolios. The fact that the rating structure has such a severe impact on the overall hedging costs for the insurer implies that companies that are willing to undergo an annuity securitization should consider their deal structure very carefully. In addition, we have pointed out that in imperfect markets, the retention of the equity tranche by the originator might be advantageous. Nevertheless, one has to bear in mind that by this behavior, the insurer is able to reduce the overall default risk in his balance sheet by securitizing a life insurance portfolio; however, the fraction of first loss pieces from defaults increases more than proportionally. The insurer has to take care to not be left with large, unwanted remaining risk positions in his books. Originality/value– In this paper, we extend on methods insurer's can use to hedge their annuity portfolio against longevity risk with the help of annuity securitization. To do so, we take the perspective of the issuing insurance company and calculate the costs of hedging in a four-step process. On the theoretical side, building on the work of Kim and Choi (2011), we adapt their pricing model to the current market situation. On the empirical side, we specify the method for the German market. Inserting specific country data into the model, price sensitivities of the presented securitization model are analyzed.

Broccardo, Eleonora; Mazzuca, Maria; Yaldiz, Elmas

2014 The Journal of Risk Finance

doi: 10.1108/JRF-04-2014-0038

Purpose– This paper aims to answer the following research questions: To what extent do banks use credit derivatives (CDs)? What are the differences between users and non-users? What are the main underlying motivations? Design/methodology/approach– The annual reports of 112 Italian banks are analysed during the 2005-2011 period. By estimating a probit regression model, two incentives for using CD are tested: managing credit risk, and increasing a bank’s income composition/diversification. Different sub-samples are considered. The motivations are further investigated to understand whether they vary before and after the crisis. Findings– A limited number of banks use CD and larger and listed banks are more likely to do so. The results do not support the hedging hypothesis. Signals pointing towards the financial distress hypothesis emerge. Less capitalised banks are more likely to use CD. For listed banks, the findings support the hypothesis that economies of scale exist. After the financial crisis, a number of determinants tend to gain significance, and a speculative driver emerges. Originality/value– Previous studies focus primarily on the USA, and single-country studies do not exist in the literature. Given the importance of risk management that the crisis has reinforced, investigating whether CD use has changed before and after the crisis is of interest. Given the incompleteness of the information on CDs, the paper contributes to increasing the available information on CDs by hand-collecting data from banks’ financial statements.

Cooper, Elizabeth; Kish, Andrew

2014 The Journal of Risk Finance

doi: 10.1108/JRF-05-2014-0068

Purpose– The purpose of this paper is to study bank executive compensation and securitization, two important strategic developments in finance that are central to the debate on the cause of the crisis. Design/methodology/approach– We study the relationship between securitization and executive pay in a sample of US banks from 2001 to 2010, using a series of multivariate regression models to test our hypotheses. Findings– Bank Chief Executive Officer (CEO) pay exhibits a positive pay-for-performance relationship. Since the crisis, this relationship is weakened. For banks that securitize, we find that prior to the crisis, higher securitization activity led to higher CEO compensation levels. While we do not find that securitization is related to bank CEO pay gap (the difference between CEO and the next-highest paid bank executive), we do see that bank ratings are a factor in pay gap and compensation level. Research limitations/implications– Bank regulatory ratings influence the relationship between compensation and securitization. Also, the relationship differs pre- and post-crisis. Originality/value– Our study is unique for several reasons. First, we look at the relationship between compensation and securitization over a time period that includes the recent financial crisis. Second, we include an analysis of pay gap. Third, we include bank regulatory ratings, which are proprietary and therefore not available for use in many banking studies.

Battaglia, Francesca; Mazzuca, Maria

2014 The Journal of Risk Finance

doi: 10.1108/JRF-07-2014-0097

Purpose– The purpose of this study was to examine the 2007-2009 financial crisis to analyze how securitization relates to the Italian bank risk profile, both in terms of credit and liquidity risks. Design/methodology/approach– To test our research hypotheses, we adopt ordered probit models, in which we regress the changes in credit risk and liquidity on a set of regressors, including two securitization dummy variables plus a vector of control variables. Findings– Our results show that the impact of securitization on the originators risk-taking is not uniform. When credit risk is considered, the securitization effects seem to be statistically significant only during the crisis period. However, when we turn to analyze the bank’s liquidity position, our results show that securitization improves it both during the pre-crisis and the crisis years. Our results support the Basel III initiatives aimed to realize a better integration between the different types of risks (i.e. credit and liquidity risks). Research limitations/implications– The major limitation of our study is related to the analyzed geographic area. Practical implications– First, our results support the Basel III initiatives aimed to realize a better integration between the different types of risks (i.e. credit and liquidity risks). In general, the broad policy implication of the paper is that in some contexts, such as the Italian market, securitization does not necessarily produce negative effects in terms of bank’s risk. Originality/value– This study contributes to the empirical literature on the effects of securitization for banks in several ways. First, we consider the complexity of the bank’s risk profile; second, despite the importance of the Italian securitization market, there is a research void on it. Furthermore, unlike previous studies, our analysis covers the period 2000-2009, including the financial crisis years. Finally, to our knowledge, our methodology (ordered probit models) has not been used in the past in this context.