Date of Award

Spring 5-2017

Embargo Period

7-31-2017

Degree Type

Dissertation (CMU Access Only)

Degree Name

Doctor of Philosophy (PhD)

Department

Tepper School of Business

Advisor(s)

Burton Hollifield

Abstract

This dissertation contains three chapters, and each examines the securitization of student loans. The first two chapters focus on the underpricing of Asset-Backed Securities (ABS) collateralized by government guaranteed student loans during the financial crisis of 2007–2009. The findings add to the literature that documents persistent arbitrages during the crisis and doing so in the ABS market is a novelty. The last chapter focuses on the securitization of private student loans, which do not benefit from government guarantees. This chapter concentrates on whether the disclosure to investors is sufficient to prevent the selection of underperforming pools of loans. My findings have normative implications for topics ranging from the regulation of securitization to central banks’ exceptional provision of liquidity during crises. Specifically, in the first chapter, “Near-Arbitrage among Securities Backed by Government Guaranteed Student Loans,” I document the presence of near-arbitrage opportunities in the student loan ABS (SLABS) market during the financial crisis of 2007–2009. I construct near-arbitrage lower bounds on the price of SLABS collateralized by government guaranteed loans. When the price of a SLABS is below its near-arbitrage lower bound, an arbitrageur that buys the SLABS, holds it to maturity and finances the purchase by frictionlessly shorting short-term Treasuries is nearly certain to make a profit. The underpricing on some SLABS relative to Treasuries exceeded 22% during the crisis. In the second chapter, “SLABS Near-Arbitrage: Accounting for Historically Unprecedented Macroeconomic Events,” I analyze whether the risks associated with unprecedented macroeconomic events, such as exceptionally high inflation or default by the government on its loan guarantee, could explain the large underpricing of SLABS relative to Treasuries observed during the financial crisis of 2007–2009. Using data on inflation caps, interest rate swaps and interest rate basis caps, and comparing the price dynamics of SLABS to other securities benefiting from a similar government guarantee, I find that for 90% of SLABS, the aforementioned risks explain at most 25% of the near-arbitrage gaps. In the third chapter, “Securitization with Asymmetric Information: The Case of PSL-ABS” (joint with Adam Ashcraft), we empirically analyze the adverse selection of loans in the private student loan (PLS) ABS market. Using loan-level data, we demonstrate the potential for an issuer of PSL-ABS to select loans in such a way that could result in materially adverse outcomes for investors (credit rating downgrades or market value losses). We find that an issuer could increase pool losses on the non-cosigned portion of securitized pools by 6%–20% among pre-crisis deals and by 16%–36% among post-crisis deals while still matching the pool characteristics disclosed to investors. The shifts in pool losses are achieved by exploiting the coarseness of the disclosure and by jointly overrepresenting unseasoned loans in the low credit score region and overrepresenting seasoned loans in the high credit score region. We present multiple additional channels for adverse selection of private student loans that could substantially increases losses without altering the disclosed characteristics of PSL-ABS deals (e.g. overrepresenting college drop-outs, the share of which is known to the securitizer but not disclosed). The existence of such channels indicates that our estimates of ABS issuers’ ability to affect pool performance via loan selection at the time of securitization should be interpreted as lower bounds.

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