Asymmetric Information and Subprime Mortgage Default
34 Pages Posted: 15 Nov 2015
Date Written: November 13, 2015
Using a novel data set, we study the soft information in subprime mortgages that is not verifiable by a third party, and its relationship with mortgage default. We find that lender effort to collect soft information is intertwined with borrower self-selection into subprime mortgages. We employ various sample stratification strategies to distinguish between two explanations, where one is more evident in some subsamples than is the other. Our results support that soft information is more evident in low-competition markets and among borrowers with low credit score, while adverse selection is more applicable to liquidity-constrained borrowers and loans originated by brokers. Both explanations are reflected in low-documentation loans, since lenders must expend greater effort collecting soft information, and borrowers have more private information to adversely select. The development and expansion of securitization has diminished soft information while increasing borrower adverse selection opportunities.
Keywords: excess premium, soft information, adverse selection, subprime mortgage
JEL Classification: D01; D12; G01; G21; R30
Suggested Citation: Suggested Citation