The Risk-Shifting Hypothesis: Evidence from Subprime Originations.

48 Pages Posted: 17 Mar 2011 Last revised: 3 Jun 2015

Augustin Landier

Toulouse School of Economics

David Alexandre Sraer

University of California, Berkeley; Princeton University

David Thesmar

MIT Sloan

Date Written: June 2, 2015


Using internal loan level data, we provide evidence consistent with risk-shifting in the lending behavior of a large subprime mortgage originator -- New Century Financial Corporation -- starting in 2004. This change follows the monetary policy tightening implemented 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 contracts. 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 contribute to better characterizing the type of risk taken by financially distressed firms. They also shed new light on the relationship between monetary policy and risk taking by financial institutions.

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

JEL Classification: G31, G32, E58

Suggested Citation

Landier, Augustin and Sraer, David Alexandre and Thesmar, David, The Risk-Shifting Hypothesis: Evidence from Subprime Originations. (June 2, 2015). AFA 2012 Chicago Meetings Paper. Available at SSRN: or

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

MIT Sloan ( email )

77 Massachusetts Avenue
Cambridge, MA 02139-4307
United States
16172259767 (Phone)

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