Job Market Paper
“Adverse Selection in the Wholesale Mortgage Market” [click to download]
This paper studies the role of private information in determining the allocation of loans through the wholesale mortgage market. Mortgage originators who sell loans in the wholesale market are often approved to securitize their mortgages with the Government Sponsored Enterprises (GSEs) by selling through the cash window. Originators decide for each loan whether to (a) sell to third-party investors in the wholesale market, or (b) securitize with the GSEs for a lower price while retaining future servicing rights and payments. I develop a simple model to explain the determinants of this choice. Originators make their decision based on a private signal about loan quality and any information conveyed by wholesale investors’ price offers. I estimate the model on a novel linked dataset that includes both GSE and investor price offers from a large loan trading platform. My results suggest that originators possess private information relevant to a loan’s future cash flows and that they leverage this private information when deciding between selling and securitizing. Furthermore, the price offers of wholesale investors are informative for originators, allowing them to refine their beliefs about loan quality and strategically allocate loans. Compared to a world where only coarse-grained loan attributes are priced, the ability to price individual loans increases the number of loans obtained by third-party investors but these additional loans are adversely selected into the wholesale market.
Working Papers
“Asymmetric information and the supply-chain of mortgages: The case of Ginnie Mae loans” (with Ken Hendricks, Jean-Francois Houde, and Diwakar Raisingh) [click to download]
This paper studies the cost of financial intermediation services provided by traditional banks and non-bank lenders in the market for mortgages. A unique feature of the supply chain of mortgages in the US is the fact that over 90% of “conforming” loans are securitized, and roughly 50% of these loans are originated and serviced by different lenders. The cost of financial intermediation is therefore determined by the resale value of loans in the secondary and wholesale markets. We develop a simple modeling framework for loan valuation in these two markets. The prices banks are willing to pay for loans in the wholesale market depend upon their resale prices in the MBS market, and on the stream of fees that they can earn from servicing the loans. The value of the loan is common to all banks, and early prepayment is the primary source of risk that they face. The main friction is private information about this risk. The goals of the paper are to validate the model of loan valuation and to test for adverse selection in the wholesale and MBS markets. We do so using a proprietary auction dataset from one of the largest loan exchange platform intermediating wholesale transactions between loan originators and banks responsible of securitizing and servicing loans. Our empirical results support the hypothesis that banks are privately and asymmetrically informed about prepayment risk, consistent with the existence of a Winner’s Curse in the mortgage market.