Discrete Dynamics in Nature and Society
Volume 2011 (2011), Article ID 849342, 64 pages
Research Article

Profit and Risk under Subprime Mortgage Securitization

Faculty of Commerce and Administration, North-West University (Mafikeng Campus), Private Bag X2046, Mmabatho 2735, South Africa

Received 7 March 2011; Accepted 29 April 2011

Academic Editor: Binggen Zhang

Copyright © 2011 M. A. Petersen et al. This is an open access article distributed under the Creative Commons Attribution License, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited.


We investigate the securitization of subprime residential mortgage loans into structured products such as subprime residential mortgage-backed securities (RMBSs) and collateralized debt obligations (CDOs). Our deliberations focus on profit and risk in a discrete-time framework as they are related to RMBSs and RMBS CDOs. In this regard, profit is known to be an important indicator of financial health. With regard to risk, we discuss credit (including counterparty and default), market (including interest rate, price, and liquidity), operational (including house appraisal, valuation, and compensation), tranching (including maturity mismatch and synthetic) and systemic (including maturity transformation) risks. Also, we consider certain aspects of Basel regulation when securitization is taken into account. The main hypothesis of this paper is that the SMC was mainly caused by the intricacy and design of subprime mortgage securitization that led to information (asymmetry, contagion, inefficiency, and loss) problems, valuation opaqueness and ineffective risk mitigation. The aforementioned hypothesis is verified in a theoretical- and numerical-quantitative context and is illustrated via several examples.