CASH-FLOW TRANCHING AND THE MACROECONOMY

The volume of cash-flow transformation activities has grown markedly over the past few decades. We develop a dynamic model that characterizes the effects of changes in the costs and benefits of security creation. Lower tranching costs and increases in foreign appetite for safe assets can both increase costly security creation with positive effects on GDP and have diverse macroeconomic implications. Whereas the former counterfactually increases yields, the latter lowers them and also raises rents associated with cash-flow transformation. These two features, as well as other subsidiary implications of increased foreign demand, are consistent with recent U.S. data.