RFS Advance Access originally published online on December 23, 2008
Review of Financial Studies 2009 22(7):2457-2494; doi:10.1093/rfs/hhn114
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Is the Market for Mortgage-Backed Securities a Market for Lemons?
Barclays Global Investors
University of California at Berkeley
Send correspondence to Nancy Wallace, Haas School of Business, University of California, Berkeley, Berkeley, CA 94720-1900; telephone: (510) 642-4732; fax: (510) 643-7357. E-mail: wallace{at}haas.berkeley.edu.
JEL Classification: D82, G13, G14, G21
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Abstract |
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This paper models and provides empirical evidence for the quality of assets that are securitized through bankruptcy remote special purpose vehicles (SPVs). The model predicts that assets sold to SPVs will be of lower quality ("lemons") compared to assets that are not sold to SPVs. We find strong empirical support for this prediction using a comprehensive data set of sales of mortgage-backed securities (Freddie Mac Participation Certificates, or PCs) to SPVs over the period 1991 through 2002. Valuation estimates based on a structural two-factor model indicate that PCs sold to SPVs are on average valued $0.39 lower per $100 of face value relative to PCs not so sold. For the four largest coupon groups in our full sample of Freddie Mac PCs, we find a "lemons spread" of 4–6 basis points in terms of yield-to-maturity, and this spread accounts for 13–45% of the overall prepayment spread of these securities.
The authors thank Peter DeMarzo, Andrea Eisfeldt, Douglas McManus, Christine Parlour, Richard Stanton, Walter Torous, Christopher Mayer, an anonymous referee, and seminar participants at Freddie Mac, NBER; Nykredit Symposium on Housing, Mortgage, and Portfolio Choice; Stockholm School of Economics, Summer Real Estate Symposium, University of Southern California, and the University of Wisconsin. Jaffee and Wallace thank the Fisher Center for Real Estate and Urban Economics for financial support. All errors are our own.