Working Papers

Competition with Multi-Dimensional Prices: Theory and Evidence from U.S. Mortgage Markets, with Greg Buchak
Supported by the Washington Center for Equitable Growth

Abstract How do lenders with market power set markups across multiple pricing dimensions? We develop a theory where lenders allocate markups across upfront fees and interest rates by trading off gains from backloading payments against prepayment risk. Using exogenous variation in refinancing costs and market concentration in the U.S. mortgage market, we show that the effect of concentration shifts from fees to rates as prepayment risk falls. We estimate a structural model to study counterfactual contract design. Rate caps reduce borrower welfare by shifting markups toward socially inefficient fees, while fee caps increase borrower welfare because prepayment risk dampens rate increases.

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.