Option compensation, risky mortgage lending, and the financial crisis

Yongqiang Chu, Xinming Li, Tao Ma, Daxuan Zhao

Research output: Contribution to journalArticlepeer-review

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.

Original languageEnglish
Article number102052
JournalJournal of Corporate Finance
Volume70
DOIs
StatePublished - Oct 2021

Keywords

  • Bank risk taking
  • FAS 123R
  • HMDA
  • Management compensation
  • Mortgage
  • Securitization
  • Stock options

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