Asymmetric Information and Vertical Integration in the Commercial Mortgage-Backed Security Market

Abstract

A commercial mortgage-backed security (CMBS) is a claim on future returns to a bundle of loans. Empirically, loans that are securitized “in-house” -- when the loan originator is vertically integrated with the issuer of the CMBS -- outperform loans securitized by unaffiliated issuers. I examine the extent to which this difference stems from ex ante selection versus the effect of vertical integration on ex post returns, such as due to moral hazard. In my model, CMBS issuers first choose a portfolio of loans, then issue securities backed by these loans that they sell to uninformed investors in a signaling game. To distinguish between ex ante selection and effects on ex post returns, I exploit exogenous variation in the set of feasible matches between issuers and loans and heterogeneity in the match values due to portfolio diversification effects. The better performance of in-house loans can be entirely explained by ex post returns -- on net, they actually have somewhat worse unobserved ex ante quality than non-in-house loans. The pricing of CMBS suggests that investors are aware of the phenomenon.

Keywords: adverse selection, asymmetric information, securitization, commercial mortgage backed securities, moment inequalities, partially identified games

JEL Classification: L1, L14, G21, G24