Market Discipline and Securitization∗

In this paper, I ask whether securitization really contributes to better risksharing. To do this, I first propose an outcome-based formalization of the concept of market discipline. Then, I compare securitization, which consist of the transfer of risk from existing loans, with other mechanisms that differ in the timing of risk-transfer. I find that, for securitization to be an efficient risk-sharing mechanism, market discipline has to be strong, that is the securitization market outcome should be better than other mechanisms at rewarding diligent loan origination, and adverse selection has to be mild, which seems to seriously restrict the set of assets that should be securitized for risk-sharing motive. Additionally, I show how ex-ante leverage may mitigate interim adverse selection in securitization markets and therefore enhance ex-post risk-sharing. This is interesting because high leverage is usually associated with “excessive” risktaking.