Relational Contracts in the Housing Market

Abstract

This paper examines relational contracts (RCs) in the housing market that exist between lenders and appraisers. We document that 42% of appraisals are at or near the contract value, while only 7.5% are below the contract. We develop an RC model and test several predictions using a novel data set that contains over 3 million appraisals. Our results confirm that appraisers produce more favorable appraisals as a reciprocity for past business from the lenders, and the response is much stronger for experienced appraisers. Lenders penalize appraisers for unfavorable appraisals by assigning fewer appraisals or terminating the business relationship. The penalty decreases once uncertainty over the appraiser type diminishes. Our theoretical model can be calibrated to fit the actual appraisal distribution. These findings demonstrate that incentives of a financial intermediary can be misaligned in the RC setting due to negative externality on third parties.

Keywords: relational contracts; appraiser; bunching; reputational concern; moral hazard; third party

JEL Classification: G21; G28; R21; R31