Option compensation,risky mortgage lending,and the financial crisis |
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| Institution: | 1. Keck Graduate Institute, Claremont Colleges, 535 Watson Drive, Claremont, CA 91711, United States of America;2. The University of Texas at Dallas, JSOM 14.502, 800 West Campbell Road, Richardson, TX 75080-3021, United States of America;3. Sabanci University, Orta Mahalle Universite Caddesi No: 27, 34956, Tuzla/Istanbul, Turkey;4. University of Memphis, 3675 Central Ave, FAB442, Memphis, TN 38152, United States of America;1. Environmental Change Institute, University of Oxford, UK;2. Smith School of Enterprise and the Environment, University of Oxford, UK;3. Cork University Business School, University College Cork, Ireland;4. School of Engineering, University College Cork, Ireland;5. MaREI Centre, Environmental Research Institute, University College Cork, Ireland;1. Gabelli School of Business, Fordham University, New York, NY 10023, USA;2. New York University, USA;1. Simon Fraser University, Burnaby, BC, Canada;2. University of California, Riverside, CA 92521, United States;3. State University of New York at Albany, NY 12222, United States |
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| Abstract: | We examine how option compensation affects banks' risky mortgage origination and sale decisions before the financial crisis in 2008. We find that, in the period immediately before the financial crisis, option compensation has little impact on the riskiness of mortgages originated and is negatively associated with mortgage lenders' propensity to sell risky mortgages. The results are consistent with banks' incentives to maximize revenues from origination and servicing fees while managing risk exposure by adjusting the sale of risky mortgages. For identification, we use bank-year fixed effects and matched loan applications to control for both supply- and demand-side factors of mortgage lending. We find similar results when using the variation in option compensation generated by the implementation of FAS 123R. |
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