Adverse Selection, Reputation and Sudden Collapses in Secondary Loan Markets

Varadarajan Chari, Ali Shourideh and Ariel Zetlin-Jones

No 16080, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Banks and financial intermediaries that originate loans often sell some of these loans or securitize them in secondary loan markets and hold on to others. New issuances in such secondary markets collapse abruptly on occasion, typically when collateral values used to secure the underlying loans fall. These collapses are viewed by policymakers as signs that the market is not functioning efficiently. In this paper, we develop a dynamic adverse selection model in which small reductions in collateral values can generate abrupt inefficient collapses in new issuances in the secondary loan market. In our model, reductions in collateral values worsen the adverse selection problem and induce some potential sellers to hold on to their loans. Reputational incentives induce a large fraction of potential sellers to hold on to their loans rather than sell them in the secondary market. We find that a variety of policies that have been proposed during the recent crisis to remedy market inefficiencies do not help resolve the adverse selection problem.

JEL-codes: E44 E50 G01 G14 G18 G38 (search for similar items in EconPapers)
Date: 2010-06
Note: CF EFG
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (20)

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