Adverse Selection in Lending: Evidence from Home Equity Cash Out Behavior

We analyze more than 74,000 home equity loans and lines of credit to study the role of information asymmetry. This credit market is characterized by borrowers who face a menu of contract options with varying collateral requirements and prices. Our results show that a less credit worthy applicant is more likely to select a credit contract that requires less collateral. Further analysis on the borrower’s repayment behavior after controlling for observable risk attributes indicates that the lender faces adverse selection and moral hazard due to private information.

Agarwal, Sumit and Chomsisengphet, Souphala and Liu, Chunlin, An Empirical Analysis of Information Asymmetry in Home Equity Lending (March 7, 2015). Journal of Financial Services Research, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2575230