Information Frictions in Securitization Markets : Unsophisticated Investors or Opaque Assets?

Security prices are informative about the probability of a subsequent downgrade, but this informativeness is affected by two frictions taking place between the issuer and the investor. I use a measure of documentation quality in private label mortgages to show that the predominant friction relates to incomplete documentation on the underlying loans. Prices of junior tranches appear no more informative than those of AAA tranches within "low-doc" deals, while the latter are no less informative within "full-doc" deals. The agency friction stemming from lack of investor sophistication is secondary. The results suggest that documentation transparency can be an effective complement to skin in the game requirements