The lemon-squeezing problem: Analytical and computational limitations in collateralized debt obligation evaluation

Research output: Contribution to journalArticle

Abstract

This article analyses collateralized debt obligations (CDOs), complex securities that were at the heart of the recent financial crisis. The difficulties of analysing these securities are considered, and it is argued that the increasing complexity of CDOs that repackaged mortgage-backed securities outpaced the returns available to investors, and therefore the resources available to pay for the analysis required to value the securities adequately within the timeframe available. CDOs therefore faced the problem of computational intractability. Such an outcome was, the article argues, inevitable in financial innovation that sought to create ever-higher returns from the fixed returns on a pool of assets. CDOs created what the article labels a lemon-squeezing problem. Implications for regulatory responses to the crisis are briefly explored.
Original languageEnglish
Pages (from-to)383-401
Number of pages19
JournalCompetition and Change
Volume18
Issue number5
Early online date9 Sep 2014
DOIs
Publication statusPublished - Oct 2014

Keywords

  • financial markets
  • financial regulation
  • financial crisis
  • derivatives
  • market devices

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