UC Berkeley

This dissertation is a collection of three essays in financial economics, specifically focused on the role of information and beliefs in credit markets. The first chapter establishes that private bank information about customers in primary lending markets exists. The second chapter shows that private information hinders banks' capacities to sell loans on secondary markets, unless the purchaser believes that the bank has committed to remain uninformed. The third chapter explores the welfare consequences of incorrect borrower beliefs about the economic environment on financial product choice.

In the first chapter, my co-author and I hypothesize that while lending to a firm, a bank receives signals that allow it to learn and better understand the firm's fundamentals; and that this learning is private; that is, it is information that is not fully reflected in publicly-observable variables. We test this hypothesis using data from the syndicated loan market between 1987 and 2003. We construct a variable that proxies for firm quality and is unobservable by the bank, so it cannot be priced when the firm enters our sample. We show that the loading on this factor in the pricing equation increases with relationship time, hinting that banks are able to learn about firm quality when they are in an established relationship with the firm.

In the second chapter, I present new evidence that lemon problems hinder trade on secondary mortgage markets. Using the geographic distance from lenders to borrowers as a proxy for the absence of private bank information, I document a systematic positive link between distance and the mortgage sale rate. Mortgage sale rates are higher when the originating lender is less likely to be informed about the borrower. I further show that the private mortgage sale rate locally depends on lender-borrower distance only above the conforming loan limit, in the illiquid jumbo market where the GSEs are barred from purchasing mortgages. This is consistent with the familiar tradeoff between market liquidity and seller incentives to acquire information.

In the third chapter, I investigate how borrowers' incorrect beliefs about future inflation might bias their choice between fixed-rate and adjustable-rate mortgages. Borrowers who have experienced recent periods of greater inflation pay more for fixed-rate mortgage contracts and pay more in interest, at least over the first six yeras of the mortgage's life. That is, incorrect beliefs about future inflation are welfare-reducing both ex ante and ex post.