Working Papers

Competition with Multi-Dimensional Pricing: Evidence from U.S. Mortgages, with Greg Buchak
Supported by the Washington Center for Equitable Growth

Abstract What do prices imply about market power when contracts are multi-dimensional? We study the U.S. mortgage market, where contracts include both interest rates and upfront fees. An extensive literature has documented little to no relationship between local lender concentration and interest rates but overlooks the multi-dimensional nature of mortgage pricing. In this paper, we show that while lenders in more concentrated markets do not charge higher rates, they do charge higher fees. We confirm these results using multiple IV strategies, exploiting both cross-sectional and time-series variation. Quantitatively, we find that a one-standard-deviation increase in local concentration is associated with an annual transfer of between $2.4 billion and $3.7 billion from borrowers to lenders (an increase in fees of between 24% and 37%); this is in addition to the welfare effects of reduced lending quantities due to higher prices. We show that the lenders’ pricing strategies are driven by two separate mechanisms: First, raising fees rather than rates minimizes the risk of prepayment, which is an ex-post transfer away from the lender. Second, by raising fees, lenders target unsophisticated borrowers for whom fees are less salient. Our results highlight a regulatory gap. Because they overlook fees, the Federal Reserve regards mortgage markets as national and views mortgage lending concentration as irrelevant for pricing, monetary policy, and financial stability. Our findings suggest that local concentration is important for borrower outcomes, and this regulatory gap is exacerbated by a growing disconnect between mortgage and deposit markets.

Integrated Intermediation and Fintech Market Power, with Greg Buchak and Vera Chau

Abstract We document that in the US residential mortgage market, the share of integrated intermediaries acting as both originator and servicer has declined dramatically. Exploiting a regulatory change, we show that borrowers with integrated servicers are more likely to refinance, and conditional on refinance, are more likely to be recaptured by their own servicer. Recaptured borrowers pay lower fees relative to other refinancers. This trend is partially offset by a rise in integrated fintech originator-servicers, who recapture at higher frequency but at worse terms. We build and calibrate a dynamic structural model to interpret these facts and quantify their impact on equilibrium outcomes. Our model suggests that integreated intermediaries enjoy a marginal cost advantage when refinancing recaptured borrowers, and fully disintegrating them would reduce refinancing frequencies and increase fees. Fintechs use technology to reacquire customers and reduce borrower inertia against refinancing. This endogenously creates market power, which fintechs exploit through higher fees. Despite worse terms ex-post, fintechs increase consumer welfare ex-ante by increasing refinancing frequencies. Taken together, our results highlight the importance of intermediaries’ scope in consumer financial outcomes and highlight a novel, quantitatively important application of fintech: customer acquisition.

Bank Technology Adoption and Loan Production in the U.S. Mortgage Market, with Sheila Jiang and Douglas Xu

Abstract Information technology plays a key role in the consumer credit market, by shaping the way lenders screen and underwrite borrowers. We study how the adoption of information technology by lenders affects approval decisions, pricing, and repayment in the U.S mortgage market. We assemble a novel loan-level dataset that covers the trajectory of mortgages from application to repayment and combine it with detailed information about IT investment by lenders. We empirically identify that higher IT investment leads lenders to increase approval rates for loan applications, introduce greater granularity in their pricing, and create loan portfolios with better ex-post performance. A simple model of screening technology investment, loan underwriting and pricing is developed to explain our empirical findings.

 

Publications

Financial Sophistication and Consumer Spending
Journal of Finance, 2024

Abstract Using detailed account-level data, this paper explores how financial sophistication affects consumers' spending responses to changes in income. I document that, controlling for liquidity, financially unsophisticated consumers display significant spending responses to predictable decreases in their disposable income. Furthermore, they have lower savings rates, fewer liquid savings, and higher debt-to-income ratios, leaving them more exposed to income shocks. Robustness tests, supported by anecdotal survey evidence, indicate that these results are driven by some consumers' lack of financial sophistication and their consequent failure to understand their financial contracts, rather than by random idiosyncratic shocks, rational liquidity management, or optimal inattention.

Sharing R&D Risk in Healthcare via FDA Hedges, with Andrew W. Lo, Tomas Philipson, Manita Singh, and Richard Thakor
Review of Corporate Finance Studies, 2022
Media: Marginal Revolution, Forbes, RAPS

Abstract Biomedical innovation suffers from a “funding gap” between the needs of drug development firms and the availability of funds. The requirement of large investments for drug development projects and the high pipeline risk associated with FDA approval causes this funding gap in part. In this paper, we propose a new financial instrument—the “FDA hedge”—that pays off upon FDA approval failure. We develop a theory to show that the FDA hedge can help eliminate the funding gap. Using novel project-level data, we establish empirically that FDA hedge risk is idiosyncratic, and show how better sharing this risk can spur welfare-enhancing R&D.