The Dodd–Frank Act and the Regulation of Risk Retention in Mortgage-Backed Securities
The Dodd–Frank Act and the Regulation of Risk Retention in Mortgage-Backed Securities
Professors Cem Demiroglu and Christopher James discuss the economic rationale for the regulation of risk retention for mortgage backed securities and review empirical work on risk retention. Dodd-Frank requires residential mortgage-backed securities sponsors to retain at least 5% of the credit risk of the mortgage. When mortgages are securitized, sponsors have less incentive to gather soft information about loan quality. There is evidence, however, that investors are aware of this decrease in incentives and price these securities appropriately. Possible refinements to the risk retention rules are proposed.
Keywords: Securitization, Qualified Residential Mortgage, QRM, RMBS, Risk Retention
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