Are Lemons Sold First? Dynamic Signaling in the Mortgage Market

Manuel Adelino, Kristopher Gerardi, and Barney Hartman-Glaser

Working Paper 2016-8a
Revised February 2017

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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 relation 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.

JEL classification: G17, G21, G23

Key words: securitization, mortgage default, adverse selection, signaling, asymmetric information

The authors thank Darren Aiello, Brendan Daley, Stuart Gabriel, Brett Green, Joseph Mason, Christopher Palmer, Anthony Pennington-Cross, Tim Riddiough, Hongfei Tang, Nancy Wallace, Paul Willen, and Basil Williams as well as seminar participants at the 2015 Southern Finance Association Conference, the 2016 American Real Estate and Urban Economics Association national conference, the 2016 Financial Intermediation Research Society conference, and the 2017 Amreican Finance Association meetings 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, Fuqua School of Business, 100 Fuqua Drive, Durham, NC 27708,; Kris Gerardi, Research Department, Federal Reserve Bank of Atlanta, 1000 Peachtree Street NE, Atlanta, GA 30309-4470,; or Barney Hartman-Glaser, Anderson School of Management, 110 Westwood Plaza, Los Angeles, CA 90095,
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