Searching for Approval

78 Pages Posted: 9 Jun 2020

See all articles by Sumit Agarwal

Sumit Agarwal

National University of Singapore

John Grigsby

University of Chicago

Ali Hortaçsu

University of Chicago

Gregor Matvos

Northwestern University - Kellogg School of Management

Amit Seru

Stanford University

Vincent Yao

Georgia State University - J. Mack Robinson College of Business

Multiple version iconThere are 2 versions of this paper

Date Written: June 2020

Abstract

We study the interaction of search and application approval in credit markets. We combine a unique dataset, which details search behavior for a large sample of mortgage borrowers, with loan application and rejection decisions. Our data reveal substantial dispersion in mortgage rates and search intensity, conditional on observables. However, in contrast to predictions of standard search models, we find a novel non-monotonic relationship between search and realized prices: borrowers, who search a lot, obtain more expensive mortgages than borrowers' with less frequent search. The evidence suggests that this occurs because lenders screen borrowers' creditworthiness, rejecting unworthy borrowers, which differentiates consumer credit markets from other search markets. Based on these insights, we build a model that combines search and screening in presence of asymmetric information. Risky borrowers internalize the probability that their application is rejected, and behave as if they had higher search costs. The model rationalizes the relationship between search, interest rates, defaults, and application rejections, and highlights the tight link between credit standards and pricing. We estimate the parameters of the model and study several counterfactuals. The model suggests that “overpayment” may be a poor proxy for consumer unsophistication since it partly represents rational search in presence of rejections. Moreover, the development of improved screening technologies from AI and big data (i.e., fintech lending) could endogenously lead to more severe adverse selection in credit markets. Finally, place based policies, such as the Community Reinvestment Act, may affect equilibrium prices through endogenous search responses rather than increased credit risk.

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Suggested Citation

Agarwal, Sumit and Grigsby, John and Hortaçsu, Ali and Matvos, Gregor and Seru, Amit and Yao, Vincent, Searching for Approval (June 2020). NBER Working Paper No. w27341, Available at SSRN: https://ssrn.com/abstract=3621847

Sumit Agarwal (Contact Author)

National University of Singapore ( email )

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

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

John Grigsby

University of Chicago ( email )

Ali Hortaçsu

University of Chicago ( email )

1101 East 58th Street
Chicago, IL 60637
United States

Gregor Matvos

Northwestern University - Kellogg School of Management ( email )

2001 Sheridan Road
Evanston, IL 60208
United States

Amit Seru

Stanford University ( email )

Stanford, CA 94305
United States

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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