Securitization Structures and Security Design

Abstract

Securitization has been a subject of interest in the security design literature, and various models have been developed in order to explain why such transactions should produce senior securities and junior securities. However securitization structures are far more complex than a simple tranching by seniority. Using a model extending the existing literature, we derive new results by considering that interest and principal should be separately contractible, and that the senior bonds in a securitization should be par-priced, both realistic constraints. This allows us to derive optimal designs closely resembling actual securitization structures. Further, we show that the resecuritization of residuals, in the form of NIMs or reremics, is optimal through a pooling effect. We also analyze the interactions between collateral characteristics and pricing, reflecting securitization execution, and issuer structure choices. With a simple numerical application, we illustrate how important resecuritization is, and also how more attractive an excess-spread structure is relative to a more standard structure, as expected collateral losses increase. According to our analysis, the apparent complexity in excess-spread structure and in resecuritizations can be explained by a valid optimal design argument.