Citations (6)



The Risk-Shifting Hypothesis: Evidence from Subprime Originations.

Augustin Landier

Toulouse School of Economics

David Alexandre Sraer

University of California, Berkeley; Princeton University

David Thesmar

HEC Paris - Finance Department

August 2, 2011

AFA 2012 Chicago Meetings Paper

Using loan level data, we provide evidence consistent with risk-shifting in the lend- ing behavior of a large subprime mortgage originator – New Century Financial Cor- poration – starting in 2004. This change follows the monetary policy tightening im- plemented by the Fed in the spring of 2004, which resulted in an adverse shock to the large portfolio of loans New Century was holding for investment. New Century reacted to this shock by massively resorting to deferred amortization loan contracts (“interest-only” loans). We show that these loans were not only riskier, but also that their returns were by design more sensitive to real estate prices than standard con- tracts. New Century was thus financing projects with a high beta on its own survival, as predicted by a standard model of portfolio selection in financial distress. Our findings shed new light on the relationship between monetary policy and risk taking by financial institutions. They also contribute to better characterizing the type of risk taken by financially distressed firms.

Number of Pages in PDF File: 48

Keywords: Risk Shifting, Subprime Mortgages, Monetary Tightening, Real Estate Risk

JEL Classification: G31, G32, E58

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Date posted: March 17, 2011 ; Last revised: March 13, 2013

Suggested Citation

Landier, Augustin and Sraer , David Alexandre and Thesmar, David, The Risk-Shifting Hypothesis: Evidence from Subprime Originations. (August 2, 2011). AFA 2012 Chicago Meetings Paper. Available at SSRN: http://ssrn.com/abstract=1786542 or http://dx.doi.org/10.2139/ssrn.1786542

Contact Information

Augustin Landier (Contact Author)
Toulouse School of Economics ( email )
Place Anatole-France
Toulouse Cedex, F-31042
David Alexandre Sraer
University of California, Berkeley ( email )
310 Barrows Hall
Berkeley, CA 94720
United States
Princeton University ( email )
22 Chambers Street
Princeton, NJ 08544
United States
David Thesmar
HEC Paris (Groupe HEC) - Finance Department ( email )
1 rue de la Liberation
Jouy-en-Josas Cedex, 78351
+33 1 39 67 94 12 (Phone)
HOME PAGE: http://www.hec.fr/hec/eng/professeurs_recherche/p_liste/p_fiche.php?num=135

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