DP11993 | Canary in a Coalmine: Securities Lending Predicting the Performance of Securitized Bonds

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In illiquid markets, trading by informed investors can have limited predictive power, because trading volumes are low and may not be timely. In these conditions, changes in the lendable amounts of securities can act as a canary in a coalmine, and predict future performance when trading activity cannot. We test this argument on the market for structured finance products (“securitized bonds”). We find strong evidence that changes in amounts available for lending (lendable) predict future performance (delinquency and foreclosure rates). In contrast, we do not find any evidence of predictability from changes in the amounts on loan. While investor trades have comparable predictive power to changes in lendable amounts in general, lendable amounts are a better predictor in illiquid markets. Overall, these findings are consistent with the hypothesis that securities holders (lenders) possess material information in this segment.