Adverse Selection in the Home Equity Line of Credit Market. Issue 3 (1st July 2018) - LaCour-Little, Michael
Abstract : Securitization has been widely assigned blame for contributing to the recent mortgage market meltdown and ensuing financial crisis. In this paper, we employ the Office of the Comptroller of the Currency (OCC) Home Equity database to develop estimates of default and prepayment probabilities for home equity lines of credit (HELOCs) originated during 2004–2008 and tracked through 2014. The results show that securitized HELOCs bear both higher default and prepayment risk compared to loans held in lender portfolios, consistent with adverse selection in the securitization process. Spreads on securitized HELOCs are higher as well, consistent with a "lemons spread." The results are robust across multiple specifications, including models that address the endogenous decision to securitize, and support adoption of the credit risk retention rule for asset-backed securities.