Systematic and liquidity risk in subprimemortgage backed securities

The misevaluation of risk in securitized \u85nancial products is central to understand-ing the Financial Crisis of 2007-2008. This paper characterizes the evolution of factors a¤ecting collateralized debt obligations (CDOs) based on subprime mortgages. A key feature of subprime-mortgage backed indices is that they are distinct in their vintage of issuance. Using a latent factor framework that incorporates this vintage e¤ect, we show the increasing importance of a common factor on more senior tranches during the crisis. We examine this common factor and its relationship with spreads. We estimate the e¤ects on the common factor of the \u85nancial crisis