Banking Competition and Shrouded Attributes: Evidence from the US Mortgage Market

57 Pages Posted: 16 Jan 2017 Last revised: 27 Nov 2017

See all articles by Sumit Agarwal

Sumit Agarwal

National University of Singapore

Changcheng Song

National University of Singapore (NUS)

Vincent Yao

Georgia State University - J. Mack Robinson College of Business

Date Written: November 20, 2017

Abstract

We document that banking deregulation increases competition, increased competition leads banks to offer lower initial rate on adjustable-rate mortgages (ARMs) to attract borrowers, but they also shroud these contracts by designing them with back-loaded resetting rates. Shrouding helps banks to offset about 73% of their losses from price discount due to competition. Deregulation increases the proportion of naïve borrowers, and banks shroud more where there is higher proportion of naïve borrowers. These results support the theory that sophisticated firms can exploit consumer biases by designing exploitative contracts. Although competition reduces firm revenues and benefits consumers initially, the overall effect is mitigated by the banks shrouding strategy.

Keywords: Deregulation; competition; shrouding; behavioral bias

JEL Classification: G21, G28, R21, R31

Suggested Citation

Agarwal, Sumit and Song, Changcheng and Yao, Vincent, Banking Competition and Shrouded Attributes: Evidence from the US Mortgage Market (November 20, 2017). Georgetown McDonough School of Business Research Paper No. 2900287. Available at SSRN: https://ssrn.com/abstract=2900287 or http://dx.doi.org/10.2139/ssrn.2900287

Sumit Agarwal

National University of Singapore ( email )

15 Kent Ridge Drive
Singapore, 117592
Singapore
8118 9025 (Phone)

HOME PAGE: http://www.ushakrisna.com

Changcheng Song (Contact Author)

National University of Singapore (NUS) ( email )

1 Arts Link, AS2 05-37
Singapore, 117568
Singapore
+6565166018 (Phone)

HOME PAGE: http://https://sites.google.com/site/songchch02/

Vincent Yao

Georgia State University - J. Mack Robinson College of Business ( email )

35 Broad Street
Atlanta, GA 30303-3083
United States

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