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Taking the Lie Out of Liar Loans: The Effect of Reduced Documentation on the Performance and Pricing of Alt-A and Subprime Mortgages

Author

Listed:
  • Michael LaCour-Little

    () (California State University)

  • Jing Yang

    () (California State University)

Abstract

We present a simple theoretical model of adverse selection when lenders allow reduced documentation. The model shows how reduced documentation attracts both riskier borrowers and larger size loans. We then empirically test implications of the model using stated income loans originated during the recent housing market run-up and collapse. After estimating the extent to which these loans have higher default rates than do fully documented loans, we develop a measure for the extent of income over-statement, providing results for both the Alt-A and subprime market segments. We also estimate that the incremental risk in these mortgages was priced at less than ten basis points.

Suggested Citation

  • Michael LaCour-Little & Jing Yang, 2013. "Taking the Lie Out of Liar Loans: The Effect of Reduced Documentation on the Performance and Pricing of Alt-A and Subprime Mortgages," Journal of Real Estate Research, American Real Estate Society, vol. 35(4), pages 507-554.
  • Handle: RePEc:jre:issued:v:35:n:4:2013:p:507-554
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    Cited by:

    1. Zhao, Yunhui, 2016. "Got Hurt for What You Paid? Revisiting Government Subsidy in the U.S. Mortgage Market," MPRA Paper 81083, University Library of Munich, Germany, revised 01 Aug 2017.
    2. James P. Dow, 2016. "Mortgage originations during 2002-2007 as an example of an evolutionary market," Journal of Evolutionary Economics, Springer, vol. 26(5), pages 1007-1032, December.

    More about this item

    JEL classification:

    • L85 - Industrial Organization - - Industry Studies: Services - - - Real Estate Services

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