Asymmetric Information in the Subprime Mortgage Market

Posted: 10 Mar 2011 Last revised: 24 Feb 2012

See all articles by James B. Kau

James B. Kau

University of Georgia - Department of Insurance, Legal Studies, Real Estate

Donald C. Keenan

University of Cergy-Pontoise; University of Georgia

Constantine Lyubimov

Federal National Mortgage Association (Fannie Mae)

V. Carlos Slawson, Jr.

Louisiana State University

Multiple version iconThere are 2 versions of this paper

Date Written: February 25, 2010

Abstract

Because of impersonal securitization in the secondary market, the ultimate investors in a mortgage have only a limited amount of information about the borrower’s characteristics. This creates an asymmetric information problem because of hidden knowledge on the part of the primary lenders, who naturally have much better access to this information. This is aggravated by the free rider problem when there are multiple investors. We discuss to what extent the secondary market then seeks to sort the loans to ameliorate this problem and what role reputations play. More importantly, however, the actions of the primary lender in terms of which kinds of loans they choose to approve are partly hidden, and this typical principal-agent situation importantly aggravates the incentive problem. To judge the nature and magnitude of this moral hazard dilemma, we use data to compare how well investors in the secondary mortgage market can predict default given the information they typically have access to as compared to the ability of primary lenders to similarly predict default given the larger set of information they typically will have access to. Finally, the implications of these results are indicated, particularly in light of the recent mortgage crisis.

Keywords: asymmetric information, subprime, mortgage default

JEL Classification: G21, D82

Suggested Citation

Kau, James B. and Keenan, Donald C. and Lyubimov, Constantine and Slawson, Jr., V. Carlos, Asymmetric Information in the Subprime Mortgage Market (February 25, 2010). Journal of Real Estate Finance and Economics, Vol.44, Nos. 1&2, 2012, Available at SSRN: https://ssrn.com/abstract=1782074

James B. Kau

University of Georgia - Department of Insurance, Legal Studies, Real Estate ( email )

Athens, GA 30602-6254
United States
706-542-9110 (Phone)
706-542-4295 (Fax)

Donald C. Keenan

University of Cergy-Pontoise ( email )

33 Boulevard du Port
Cergy-Pontoise Cedex, Cedex 95011
France

University of Georgia ( email )

510 Brooks Hall
Athens, GA 30602
United States
706-542-3668 (Phone)

Constantine Lyubimov (Contact Author)

Federal National Mortgage Association (Fannie Mae) ( email )

3900 Wisconsin Avenue, NW
Washington, DC 20016-2892
United States

V. Carlos Slawson, Jr.

Louisiana State University ( email )

E. J. Ourso College of Business
Department of Finance
Baton Rouge, LA 70803-6308
United States
225-578-6291 (Phone)

HOME PAGE: http://www.lsu.edu/business/finance/profile-viewer.php?un=cslawson

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