This paper examines whether underwriters of prime mortgage-backed securities exploit private information when trading in the secondary market. While underwriters bid on more than 83 percent of their own tranches, the tranches they avoid bidding on have fewer bidders and exhibit worse-than-average ex-post performance. Most strikingly, when an underwriter declines to submit a bid at a secondary market sale, 30-day delinquent loans are about 3 times as likely to roll to 60-days delinquent in the next month compared to pools where the underwriter bids. The increased likelihood of missing the next payment only occurs in the next month, when data on such missed payments may be available to affiliates of the underwriter. Underwriters also avoid bidding on securities that have lower payoff rates in the four months after the auction. Instead of acting as unbiased market makers, underwriters appear to exploit private information and better models to their own advantage. These results suggest a lemons problem in secondary mortgage markets that might help explain some of the recent turmoil in the CDO market and why investment banks have moved towards vertical integration in the MBS market.
Drucker, Steven, and Christopher Mayer. "Private Information and Market Making in Secondary Mortgage Markets." Working paper, Columbia Business School, December 15, 2010.
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