We study the impacts of the recently proposed risk retention regulation for asset securitization, i.e. the issuer has to retain a certain proportion of securitized assets. We also consider the frequently discussed measure to require the issuer disclose certain information of the securitized assets. In a dynamic model with asymmetric information between a risk-averse originating bank and a continuum of risk-averse investors, we find that it is impossible for a flat-rate retention requirement to be optimal for all asset types. Although both risk retention and information disclosure regulations are effective in reducing investors’ informational loss, neither can unconditionally enhance social welfare upon the unregulated case. For both measures, there are associated regulatory cost: risk retention regulation aggravates adverse selection problem because it undermines the channel of informational revelation by the choice of securitization intensity, and information disclosure requirement incurs a signalling cost by distorting banks’ securitization intensity in sending signals. Under an appropriate set of conditions we find that information disclosure requirement complements risk retention regulation when investors are sufficiently risk averse.

This paper examines how, in the presence of individual risk, economic efficiency can be achieved without an unrealistically large number of contingent claims. Market uncertainty is specified in such a way that general types of individual risk and collective risk are properly accounted for and so that, specifically, market clearing is always satisfied ex post as well as ex ante. We show that consistency of beliefs and optimality of allocation can be guaranteed with an appropriate array of pure Arrow securities to spread collective risk and mutual insurance policies to pool individual risk. When there is individual risk common to like groups of individuals, pooling risk by means of mutual insurance permits substantial economizing on market transactions, as compared to those required if dealing instead with the full complement of pure Arrow securities. We show that if there are N households (consisting of H types), each facing the possibility of being in S individual states together with T collective states, then ensuring Pareto optimality requires only H(S-1)T independent mutual insurance policies plus T pure Arrow securities. Our results also help to clarify the question of which missing markets may affect allocational efficiency.