Are Lemons Sold First? Dynamic Signaling in the Mortgage Market

Manuel Adelino, Kristopher Gerardi, and Barney Hartman-Glaser

Working Paper 2016-8b
Revised March 2018

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A central result in the theory of adverse selection in asset markets is that informed sellers can signal quality and obtain higher prices by delaying trade. This paper provides some of the first evidence of a signaling mechanism through trade delays using the residential mortgage market as a laboratory. We find a strong relationship between mortgage performance and time to sale for privately securitized mortgages. Additionally, deals made up of more seasoned mortgages are sold at lower yields. These effects are strongest in the "Alt-A" segment of the market, where mortgages are often sold with incomplete hard information, and in cases where the originator and the issuer of mortgage-backed securities are not affiliated.

JEL classification: G17, G21, G23

Key words: mortgage markets, asymmetric information, signaling


The authors thank the editor Toni Whited, the anonymous referee, Darren Aiello, Brendan Daley, Stuart Gabriel, Brett Green, Joseph Mason, Christopher Palmer, Anthony Pennington-Cross, Tim Riddiough, Hongfei Tang, Nancy Wallace, Paul Willen, Basil Williams, James Vickery, conference participants at the AFA, AREUEA National Conference, Annual CEPR Symposium, CHUM, FIRS, and NBER Corporate Finance, and seminar participants at Columbia, Duke, MIT (Sloan), Minnesota (Carlson), Northwestern (Kellogg), Pittsburgh (Katz), Virginia (McIntire), University of Colorado at Boulder, UNC Charlotte, and Wharton for their helpful comments and discussions. They also thank Valeria Vargas-Sejas for her outstanding research assistance. This paper was previously circulated under the title "A Test of Dynamic Signaling Models: Evidence from Mortgage Securitization." The views expressed here are the authors' and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors' responsibility.
Please address questions regarding content to Manuel Adelino (contact author), Fuqua School of Business, 100 Fuqua Drive, Durham, NC 27708, 919-660-7981, manuel.adelino@duke.edu; Kris Gerardi, Research Department, Federal Reserve Bank of Atlanta, 1000 Peachtree Street NE, Atlanta, GA 30309-4470, kristopher.gerardi@atl.frb.org; or Barney Hartman-Glaser, Anderson School of Management, 110 Westwood Plaza, Los Angeles, CA 90095, bhglaser@anderson.ucla.edu.
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