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Lender Moral Hazard and Reputation in Originate-to-Distribute Markets

74 Pages Posted: 17 Jan 2012 Last revised: 26 Mar 2015

Andrew Winton

University of Minnesota - Twin Cities - Carlson School of Management

Vijay Yerramilli

University of Houston, C. T. Bauer College of Business

Date Written: March 15, 2015

Abstract

In a dynamic model of originate-to-distribute lending, we examine whether reputation concerns can incentivize a bank to monitor loans it has sold. Investors believe that banks with fewer recent loan defaults are more likely to monitor ("have higher reputation''). In equilibrium, banks monitor more and retain a smaller loan fraction when their reputations are high. Monitoring is harder to sustain in periods with uncommonly large spikes in loan demand ("booms''), especially for low-reputation banks, which are more likely to accommodate boom demand and forgo monitoring. Increased likelihood of facing a rival with reputation concerns also weakens monitoring incentives.

Keywords: Monitoring, Reputation, Default

JEL Classification: G20, G21, L14

Suggested Citation

Winton, Andrew and Yerramilli, Vijay, Lender Moral Hazard and Reputation in Originate-to-Distribute Markets (March 15, 2015). Available at SSRN: https://ssrn.com/abstract=1986956 or http://dx.doi.org/10.2139/ssrn.1986956

Andrew Winton

University of Minnesota - Twin Cities - Carlson School of Management ( email )

321 19th Avenue South
Department of Finance
Minneapolis, MN 55455
United States
612-624-0589 (Phone)
612-626-1335 (Fax)

Vijay Yerramilli (Contact Author)

University of Houston, C. T. Bauer College of Business ( email )

Houston, TX 77204
United States
713-743-2516 (Phone)

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