Chemla is with Imperial College Business School, DRM/CNRS, and CEPR, and Hennessy is with London Business School, CEPR, and ECGI. We thank Andres Almazan, Sudipto Bhattacharya, Patrick Bolton, James Dow, Sergei Guriev, Michel Habib, Yolande Hiriart, David Martimort, Sebastien Pouget, Jean Charles Rochet, Jean Tirole, and Sheridan Titman for helpful feedback. We also thank seminar participants at Harvard, LBS, UT Austin, Maryland, ASU, Zurich, Institut Bachelier, IDC (Israel), Université Paris Dauphine, Université de Franche-Comté (Besançon), Queen Mary, NES, NHH, University of Naples, Georgia State, IESEG–Paris, City University London, VGSF, CFTC, and Banque de France. Chemla received support from Chaire Finance et Développement Durable and Hennessy received funding from a European Research Council grant during the course of this research.
Skin in the Game and Moral Hazard
Article first published online: 18 JUL 2014
© 2014 the American Finance Association
The Journal of Finance
Volume 69, Issue 4, pages 1597–1641, August 2014
How to Cite
CHEMLA, G. and HENNESSY, C. A. (2014), Skin in the Game and Moral Hazard. The Journal of Finance, 69: 1597–1641. doi: 10.1111/jofi.12161
- Issue published online: 18 JUL 2014
- Article first published online: 18 JUL 2014
- Accepted manuscript online: 26 MAR 2014 01:50PM EST
- Manuscript Accepted: 17 FEB 2014
- Manuscript Received: 3 AUG 2011
- European Research Council
What determines securitization levels, and should they be regulated? To address these questions we develop a model where originators can exert unobservable effort to increase expected asset quality, subsequently having private information regarding quality when selling ABS to rational investors. Absent regulation, originators may signal positive information via junior retentions or commonly adopt low retentions if funding value and price informativeness are high. Effort incentives are below first-best absent regulation. Optimal regulation promoting originator effort entails a menu of junior retentions or one junior retention with size decreasing in price informativeness. Zero retentions and opacity are optimal among regulations inducing zero effort.