Collateralized Mortgage Obligation

Abstract: This thesis set out to explain the securitization process of subprime mortgages in order to investigate if there exist inherent  factors  of  the process  that may have  contributed  to  the  recent  subprime  crisis. A  thorough  exposition  of securitization  theory  is made  together with  simulations  of  how  cash  flows  and  credit  risks  are  estimated  by  the market. We present two inherent factors that possibly have facilitated the exacerbation of the subprime crisis, how the transferring of risk is conducted and the complexity of the product which produce information asymmetry. We also find that the market standard model for estimating risk of Collateralized Mortgage Obligations, the reduced form  one  factor Gaussian Copula model, has weaknesses  that makes  the model  sensitive  to assumptions  on  the underlying assets. In our analysis we find it ex post puzzling to think that the market had so much confidence in the securitization of subprime mortgage loans to transform originally bad loans to safe investment vehicles.