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Prepared by Martin Mühleisen.
For example, the tranching of MBS backed by sub-prime mortgages and home equity loans allows risk-averse investors to pick up yield at limited exposure, while some of the substantive credit risk is borne by investors with a stronger risk appetite (e.g., hedge funds and speculative bond funds).
Data on portfolio allocations suggest that foreign investors are not overweight U.S. assets, although the size of U.S. net foreign liabilities has become large compared to other countries even when factors such as the size and openness of the U.S. economy are taken account of (Swiston, 2005).
Balakrishnan and Tulin (forthcoming) point out that foreign investors have not demanded a risk premium to invest in U.S. assets, as expectations of dollar depreciation were only partly being offset by growing interest differentials in favor of the United States.
Exotic mortgages have only begun to spread as better data and more refined financial tools have become available to lenders, including complex behavioral models and sophisticated financial innovations that allow the tailoring of attendant risks to dedicated investor classes.