IDEAS home Printed from https://ideas.repec.org/p/tse/wpaper/25604.html
   My bibliography  Save this paper

The risk-Shifting Hypothesis : Evidence from Subprime Originations

Author

Listed:
  • Landier, Augustin
  • Sraer, David
  • Thesmar, David

Abstract

Using loan level data, we provide evidence consistent with risk-shifting in the lending behavior of a large subprime mortgage originator { New Century Financial Corporation { starting in 2004. This change follows the monetary policy tightening implemented by the Fed in the spring of 2004, which resulted in an adverse shock to the large portfolio of loans New Century was holding for investment. New Century reacted to this shock by massively resorting to deferred amortization loan contracts (\interest-only" loans). We show that these loans were not only riskier, but also that their returns were by design more sensitive to real estate prices than standard contracts. New Century was thus financing projects with a high beta on its own survival, as predicted by a standard model of portfolio selection in financial distress. Our findings shed new light on the relationship between monetary policy and risk taking by financial institutions. They also contribute to better characterizing the type of risk taken by financially distressed firms.

Suggested Citation

  • Landier, Augustin & Sraer, David & Thesmar, David, 2011. "The risk-Shifting Hypothesis : Evidence from Subprime Originations," TSE Working Papers 11-279, Toulouse School of Economics (TSE).
  • Handle: RePEc:tse:wpaper:25604
    as

    Download full text from publisher

    File URL: http://www.tse-fr.eu/sites/default/files/medias/doc/wp/fit/wp_tse_279.pdf
    File Function: Full text
    Download Restriction: no

    References listed on IDEAS

    as
    1. Greenwood, Robin & Thesmar, David, 2011. "Stock price fragility," Journal of Financial Economics, Elsevier, pages 471-490.
    2. Markus K. Brunnermeier & Lasse Heje Pedersen, 2009. "Market Liquidity and Funding Liquidity," Review of Financial Studies, Society for Financial Studies, pages 2201-2238.
    3. Jeremy C. Stein, 2012. "Monetary Policy as Financial Stability Regulation," The Quarterly Journal of Economics, Oxford University Press, vol. 127(1), pages 57-95.
    4. Shleifer, Andrei & Vishny, Robert W, 1992. " Liquidation Values and Debt Capacity: A Market Equilibrium Approach," Journal of Finance, American Finance Association, vol. 47(4), pages 1343-1366, September.
    5. Diebold, Francis X. & Yılmaz, Kamil, 2014. "On the network topology of variance decompositions: Measuring the connectedness of financial firms," Journal of Econometrics, Elsevier, pages 119-134.
    6. Allen, Franklin & Babus, Ana & Carletti, Elena, 2012. "Asset commonality, debt maturity and systemic risk," Journal of Financial Economics, Elsevier, pages 519-534.
    7. Viral V. Acharya & Lasse H. Pedersen & Thomas Philippon & Matthew Richardson, 2010. "Measuring systemic risk," Working Paper 1002, Federal Reserve Bank of Cleveland.
    8. Coralio Ballester & Antoni Calvo-Armengol & Yves Zenou, 2005. "Who's Who in Networks. Wanted: the Key Player," NajEcon Working Paper Reviews 666156000000000586, www.najecon.org.
    9. Demange, Gabrielle, 2012. "Contagion in financial networks: A threat index," CEPR Discussion Papers 8793, C.E.P.R. Discussion Papers.
    10. Stefano Giglio, 2016. "Credit default swap spreads and systemic financial risk," ESRB Working Paper Series 15, European Systemic Risk Board.
    11. Kiyotaki, Nobuhiro & Moore, John, 1997. "Credit Cycles," Journal of Political Economy, University of Chicago Press, pages 211-248.
    12. Viral V. Acharya & Philipp Schnabl, 2010. "Do Global Banks Spread Global Imbalances? The Case of Asset-Backed Commercial Paper During the Financial Crisis of 2007-09," NBER Working Papers 16079, National Bureau of Economic Research, Inc.
    13. Denis Gromb & Dimitri Vayanos, 2010. "Limits of Arbitrage: The State of the Theory," NBER Working Papers 15821, National Bureau of Economic Research, Inc.
    14. Billio, Monica & Getmansky, Mila & Lo, Andrew W. & Pelizzon, Loriana, 2012. "Econometric measures of connectedness and systemic risk in the finance and insurance sectors," Journal of Financial Economics, Elsevier, pages 535-559.
    15. Darrell Duffie, 2013. "Systemic Risk Exposures: A 10-by-10-by-10 Approach," NBER Chapters,in: Risk Topography: Systemic Risk and Macro Modeling, pages 47-56 National Bureau of Economic Research, Inc.
    16. Franklin Allen & Ana Babus & Elena Carletti, 2010. "Financial Connections and Systemic Risk," NBER Chapters,in: Market Institutions and Financial Market Risk National Bureau of Economic Research, Inc.
    17. Chotibhak Jotikasthira & Christian Lundblad & Tarun Ramadorai, 2012. "Asset Fire Sales and Purchases and the International Transmission of Funding Shocks," Journal of Finance, American Finance Association, vol. 67(6), pages 2015-2050, December.
    18. Andrei Shleifer & Robert Vishny, 2011. "Fire Sales in Finance and Macroeconomics," Journal of Economic Perspectives, American Economic Association, pages 29-48.
    19. Ellul, Andrew & Jotikasthira, Chotibhak & Lundblad, Christian T., 2011. "Regulatory pressure and fire sales in the corporate bond market," Journal of Financial Economics, Elsevier, vol. 101(3), pages 596-620, September.
    20. Peter Feldhütter, 2012. "The Same Bond at Different Prices: Identifying Search Frictions and Selling Pressures," Review of Financial Studies, Society for Financial Studies, pages 1155-1206.
    21. Hamed Amini & Rama Cont & Andreea Minca, 2012. "Stress Testing The Resilience Of Financial Networks," World Scientific Book Chapters,in: Finance at Fields, chapter 2, pages 17-36 World Scientific Publishing Co. Pte. Ltd..
    22. Markus K. Brunnermeier, 2009. "Deciphering the Liquidity and Credit Crunch 2007-2008," Journal of Economic Perspectives, American Economic Association, pages 77-100.
    23. Greenwood, Robin, 2005. "Short- and long-term demand curves for stocks: theory and evidence on the dynamics of arbitrage," Journal of Financial Economics, Elsevier, vol. 75(3), pages 607-649, March.
    24. Coval, Joshua & Stafford, Erik, 2007. "Asset fire sales (and purchases) in equity markets," Journal of Financial Economics, Elsevier, vol. 86(2), pages 479-512, November.
    25. Gorton, Gary & Metrick, Andrew, 2012. "Securitized banking and the run on repo," Journal of Financial Economics, Elsevier, pages 425-451.
    26. Larry Eisenberg & Thomas H. Noe, 2001. "Systemic Risk in Financial Systems," Management Science, INFORMS, pages 236-249.
    27. Steven Drucker & Manju Puri, 2009. "On Loan Sales, Loan Contracting, and Lending Relationships," Review of Financial Studies, Society for Financial Studies, pages 2635-2672.
    28. Markus K. Brunnermeier & Gary Gorton & Arvind Krishnamurthy, 2012. "Risk Topography," NBER Macroeconomics Annual, University of Chicago Press, vol. 26(1), pages 149-176.
      • Markus K. Brunnermeier & Gary Gorton & Arvind Krishnamurthy, 2011. "Risk Topography," NBER Chapters,in: NBER Macroeconomics Annual 2011, Volume 26, pages 149-176 National Bureau of Economic Research, Inc.
    29. Adrian, Tobias & Shin, Hyun Song, 2010. "Liquidity and leverage," Journal of Financial Intermediation, Elsevier, pages 418-437.
    30. Adrian, Tobias & Shin, Hyun Song, 2010. "Liquidity and leverage," Journal of Financial Intermediation, Elsevier, pages 418-437.
    31. repec:hrv:faseco:33077925 is not listed on IDEAS
    32. Coralio Ballester & Antoni Calvó-Armengol & Yves Zenou, 2006. "Who's Who in Networks. Wanted: The Key Player," Econometrica, Econometric Society, pages 1403-1417.
    33. Berger, Allen N. & Turk-Ariss, Rima, 2010. "Do Depositors Discipline Banks? An International Perspective," Working Papers 11-25, University of Pennsylvania, Wharton School, Weiss Center.
    34. Konstantin Milbradt, 2012. "Level 3 Assets: Booking Profits and Concealing Losses," Review of Financial Studies, Society for Financial Studies, pages 55-95.
    35. repec:wsi:ijtafx:v:15:y:2012:i:01:n:s0219024911006504 is not listed on IDEAS
    36. Ang, Andrew & Longstaff, Francis A., 2013. "Systemic sovereign credit risk: Lessons from the U.S. and Europe," Journal of Monetary Economics, Elsevier, pages 493-510.
    37. Wolf Wagner, 2011. "Systemic Liquidation Risk and the Diversity–Diversification Trade‐Off," Journal of Finance, American Finance Association, vol. 66(4), pages 1141-1175, August.
    38. Todd C. Pulvino, 1998. "Do Asset Fire Sales Exist? An Empirical Investigation of Commercial Aircraft Transactions," Journal of Finance, American Finance Association, vol. 53(3), pages 939-978, June.
    39. Ang, Andrew & Longstaff, Francis A., 2013. "Systemic sovereign credit risk: Lessons from the U.S. and Europe," Journal of Monetary Economics, Elsevier, pages 493-510.
    40. Daron Acemoglu & Asuman Ozdaglar & Alireza Tahbaz-Salehi, 2010. "Cascades in Networks and Aggregate Volatility," NBER Working Papers 16516, National Bureau of Economic Research, Inc.
    41. Hamed Amini & Rama Cont & Andreea Minca, 2012. "Stress testing the resilience of financial networks," Post-Print hal-00801538, HAL.
    42. Viral V Acharya & Philipp Schnabl, 2010. "Do Global Banks Spread Global Imbalances? Asset-Backed Commercial Paper during the Financial Crisis of 2007–09," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 58(1), pages 37-73, August.
    43. Darrell Duffie, 2010. "Presidential Address: Asset Price Dynamics with Slow-Moving Capital," Journal of Finance, American Finance Association, vol. 65(4), pages 1237-1267, August.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Adrian, Tobias & Liang, J. Nellie, 2014. "Monetary policy, financial conditions, and financial stability," Staff Reports 690, Federal Reserve Bank of New York, revised 01 Dec 2016.
    2. Iachan, Felipe Saraiva, 2017. "Capital budgeting and risk taking under credit constraints," FGV/EPGE Economics Working Papers (Ensaios Economicos da EPGE) 786, FGV/EPGE - Escola Brasileira de Economia e Finanças, Getulio Vargas Foundation (Brazil).
    3. Berndt, Antje & Hollifield, Burton & Sandås, Patrik, 2017. "What Broker Charges Reveal about Mortgage Credit Risk," Working Paper Series 336, Sveriges Riksbank (Central Bank of Sweden).
    4. Arthur Korteweg & Morten Sorensen, 2012. "Estimating Loan-to-Value and Foreclosure Behavior," NBER Working Papers 17882, National Bureau of Economic Research, Inc.
    5. Beirne, John & Friedrich, Christian, 2017. "Macroprudential policies, capital flows, and the structure of the banking sector," Journal of International Money and Finance, Elsevier, vol. 75(C), pages 47-68.
    6. Demyanyk, Yuliya & Loutskina, Elena, 2016. "Mortgage companies and regulatory arbitrage," Journal of Financial Economics, Elsevier, pages 328-351.
    7. Hanson, Samuel G. & Stein, Jeremy C., 2015. "Monetary policy and long-term real rates," Journal of Financial Economics, Elsevier, vol. 115(3), pages 429-448.
    8. Nicola Pavoni & Hakki Yazici, 2017. "Intergenerational Disagreement and Optimal Taxation of Parental Transfers," Review of Economic Studies, Oxford University Press, pages 1264-1305.
    9. Kogler, Michael, 2015. "Rewarding Prudence: Risk Taking, Pecuniary Externalities and Optimal Bank Regulation," Economics Working Paper Series 1512, University of St. Gallen, School of Economics and Political Science.

    More about this item

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:tse:wpaper:25604. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (). General contact details of provider: http://edirc.repec.org/data/tsetofr.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.