Overcoming Inefficiencies in the Pricing of Structured Finance Instruments

Abstract

Unlike the market for heavily traded stocks, there is much less transparency into the pricing of fixed-income securities, with particular inefficiencies in the market for structured finance securities. For reasons described in the article, companies and funds can yield significant advantages by inflating the value of their assets. Meanwhile, financial market regulators, attuned to the incentive structure, have been aggressive in investigating the potential for “mis-markings.” Wide discrepancies can be seen between the valuations used by different companies and, at times, even between the levels shown for the same security held in different portfolios at a single company. Several of these discrepancies can easily—and innocently—be explained in the structured finance markets, due to various inefficiencies. This article explores some of the reasons the structured finance market is prone to such inefficiencies and is particularly vulnerable to them during a stressed market environment—and provides suggestions for possible improvements.