Neighborhood Information Externalities and the Provision of Mortgage Credit

Recent theoretical models and empirical analyses argue that mortgage market activity creates information and lowers the costs of underwriting mortgages. We re-examine this question using models that control for neighborhood-lender fixed effects and address the potential endogeneity of market volume using information on lagged volumes. We find that the omission of neighborhood fixed effects substantially biases analyses of the effect of neighborhood volume on underwriting, and our tests imply that the one or two period lags of volume typically used in cross-sectional studies cannot be treated as exogenous due to the persistence of neighborhood economic shocks. In our preferred specification, we cannot rule out the possibility that overall market activity has a small positive influence on mortgage underwriting, but the statistical evidence for the existence of such effects is weak. On the other hand, we find that lender-specific activity in a neighborhood has strong positive effects on the mortgage approval decision, and this effect is underestimated in traditional cross-sectional models.