Advantageous Selection with Intermediaries: A Study of GSE-Securitized Mortgage Loans

Abstract

This paper studies the effects of mortgage subsidies and asymmetric information in the U.S. mortgage market. I exploit discontinuities in interest rates generated by pricing rules and find patterns consistent with advantageous selection. I estimate an industry model that highlights the relationship between mortgage subsidies, intermediary lenders' incentives, and borrowers' advantageous selection. The model shows that mortgage subsidies enable advantageous selection, creating a deadweight loss of 7.90 billion. The counterfactual analysis reveals that pricing borrowers' private information eliminates advantageous selection only if mortgages are not subsidized. Without the mortgage subsidy, pricing borrowers' private information further improves efficiency by 728.58 million.

Keywords: Advantageous selection, imperfect competition, financial intermediaries, vertical market, pricing, mortgage

JEL Classification: D82, G21, L11, L22