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Prime vs. Subprime: Asymmetric Information and Equilibrium Securitization in a Business Cycle Model

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  • Federico Ravenna

Abstract

We study the implications for the business cycle and monetary policy of loan securitization in a DSGE model where information asymmetries lead to adverse selection across financial intermediaries. Securitization is an endogenous equilibrium outcome when the resources saved by acquiring incomplete information about some risk-classes of borrowers outweigh the cost of being selected against by mortgage originators. Adverse selection results in a time-varying market share of individually risk-priced loans held by banks, and of securitized loans held by the secondary market. We analyze the impact of conventional monetary policies and credit market policies in response to an increase in default risk, and discuss its welfare implications. Overall securitization allows more efficient funding of loans, at the expense of increased volatility in risky interest rates, consumption, and inflation over the business cycle.

Suggested Citation

  • Federico Ravenna, 2025. "Prime vs. Subprime: Asymmetric Information and Equilibrium Securitization in a Business Cycle Model," Carlo Alberto Notebooks 751 JEL Classification: E, Collegio Carlo Alberto.
    • Handle: RePEc:cca:wpaper:751
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