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Collateral Risk and Demographic Discrimination in Mortgage Market Equilibria

David Nickerson () and Robert Jones ()
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David Nickerson: Rogers School of Management, Ryerson University, 350 Victoria Street, Toronto, Ontario M5B 2K3, CANADA
Robert Jones: Department of Economics, Simon Fraser University, 8888 University Dr, Burnaby, BC V5A 1S6, CANADA

Review of Economics & Finance, 2017, vol. 9, 13-28

Abstract: Observations of significant differences in loan terms between demographically distinct groups of borrowers are often interpreted as evidence of ethnic, racial or gender discrimination by lenders. We consider, in stark contrast to existing models of demographic discrimination, a model of mortgage lending in an economy having complete markets, common knowledge and arbitragefree pricing. Market equilibria in this classical environment may exhibit discriminatory loan pricing by lenders even when borrowers, distinguished only by differences in an observable demographic trait, share identical measures of individual credit risk. Such pricing will be observed if these traits are directly correlated with certain features of the property securing a mortgage loan which, while omitted from standard statistical underwriting and regulatory review procedures, reduce the value of the collateral to the lender in case of foreclosure. When loans are secured by such properties and both lenders and borrowers act strategically, discrimination on this basis maximizes mortgage returns to lenders and will invariably be observed in mortgage market equilibria.

Keywords: Credit rationing; Discrimination; Efficient markets; Perfect equilibrium (search for similar items in EconPapers)
JEL-codes: G13 G15 O16 (search for similar items in EconPapers)
Date: 2017
Note: The authors' names appear in a random order. They would like to thank Xiaoling Ang, Cynthia Holmes, Robert van Order, and seminar participants at the Consumer Financial Protection Bureau (CFPB), Ryerson University, and The University of Toronto for helpful comments on earlier drafts.
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