Essays in financial economics

Abstract

The first chapter studies the impact of house price expectations together with securitization, on the magnitude of risky mortgage lending by banks. This chapter first presents a simple model to explore the impact of both house price expectations and the growth of securitization on the extent of subprime lending. The model shows that a high expectation of housing prices not only increases lenders' willingness to lend to riskier borrowers, but, in addition, enhances the attractiveness of the originate-to-distribute (OTD) model of lending. Access to securitization markets also amplifies banks' incentives to lend to sub-prime borrowers and leads to a worsening of mortgage-market credit quality. Thus, when housing prices decline, the extent of defaults is magnified with OTD lending. Empirical findings confirm the model's predictions. In particular, the results show that, in markets with higher housing price growth, banks with higher OTD participation extended mortgages to riskier borrowers, and thus, had larger incidence of defaults once house prices declined. The second chapter models the interaction between lending institutions and credit rating agencies under different economic scenarios, where an originator window dresses claims it issues and a credit rating agency (CRA) screens. Both window dressing and screening efforts are shown to depend on the state of the economy: better states exhibit greater window dressing and less screening. The rating quality and default probability for given ratings also vary with economic conditions, and credit spreads adjust to such variations. The third chapter examines how retirement affects households portfolio choice. Conventional wisdom suggests that when income is substantially reduced after retirement, households should hold more safe assets in their portfolios. The data, however, show that, on average, retirement causes an approximately five to seven percent increase in the share of risky assets in households' portfolios. In addition, this positive shift mostly happens right after retirement immediately and is mainly driven by the fact that households without risky assets start to hold risky assets after retirement. Evidence in support of (a) shifts in risk tolerance and (b) spending additional time tracking the stock market is presented.