[We develop a model for markets for catastrophic risk. The model explains why insurance providers may choose not to offer insurance for catastrophic risks and not to participate in reinsurance markets, even though there is a large enough market capacity to reach full risk sharing through diversification in a reinsurance market. This is a "nondiversification trap." We show that nondiversification traps may arise when risk distributions have heavy left tails and insurance providers have limited liability. When they are present, there may be a coordination role for a centralized agency to ensure that risk sharing takes place.]

This paper models and provides empirical evidence for the quality of assets that are securitized through bankruptcy remote special purpose vehicles (SPVs). The model predicts that assets sold to SPVs will be of lower quality (“lemons”) compared to assets that are not sold to SPVs. We find strong empirical support for this prediction using a comprehensive data set of sales of mortgage-backed securities (Freddie Mac Participation Certificates, or PCs) to SPVs over the period 1991 through 2002. Valuation estimates based on a structural two-factor model indicate that PCs sold to SPVs are on average valued $0.39 lower per $100 of face value relative to PCs not so sold. For the four largest coupon groups in our full sample of Freddie Mac PCs, we find a “lemons spread” of 4–6 basis points in terms of yield-to-maturity, and this spread accounts for 13–45% of the overall prepayment spread of these securities.

[This paper models and provides empirical evidence for the quality of assets that are securitized through bankruptcy remote special purpose vehicles (SPVs). The model predicts that assets sold to SPVs will be of lower quality ("lemons") compared to assets that are not sold to SPVs. We find strong empirical support for this prediction using a comprehensive data set of sales of mortgage-backed securities (Freddie Mac Participation Certificates, or PCs) to SPVs over the period 1991 through 2002. Valuation estimates based on a structural two-factor model indicate that PCs sold to SPVs are on average valued $0.39 lower per $100 of face value relative to PCs not so sold. For the four largest coupon groups in our full sample of Freddie Mac PCs, we find a "lemons spread" of 4-6 basis points in terms of yield-to-maturity, and this spread accounts for 13-45% of the overall prepayment spread of these securities.]

Dwight M. Jaffee, Kenneth T. Rosen, Estimates of the Effectiveness of Stabilization Policies for the Mortgage and Housing Markets, The Journal of Finance, Vol. 33, No. 3, Papers and Proceedings of the Thirty-Sixth Annual Meeting American Finance Association, New York City December 28-30, 1977 (Jun., 1978), pp. 933-946