Informed and Uninformed Investment in Housing: The Downside of Diversification

Abstract:     
Mortgage lenders that concentrate in few markets invest more in information collection than diversified lenders. Concentrated lenders focus on the information-intensive jumbo market and on high-risk borrowers. They are better positioned to price risks and thus ration credit less. Adverse selection, however, leads to higher retention of mortgages relative to diversified lenders. Finally, concentrated lenders have higher profits than diversified lenders, their profits vary less systematically, and their stock prices fell less during the 2007-08 credit crisis. The results imply that geographic diversification led to a decline in screening by lenders which likely played a role in the 2007-2008 Crisis.

Number of Pages in PDF File: 49

Keywords: sub-prime mortgages, housing crisis

JEL Classification: G2

Accepted Paper Series