Disagreement in Collateral Valuation

Jordan Martel, Michael Woeppel - Aug 03, 2023

Working Paper No.  00124-00

We present a model of secured lending in which borrowers and lenders agree to disagree about collateral values. Lenders' beliefs distort equilibrium prices of collateralized assets, and the extent to which lenders' beliefs distort prices is mediated by borrower riskiness. Specifically, prices are more reflective of lenders' beliefs when borrowers are riskier and more reflective of borrowers' beliefs when borrowers are safer. Disagreement in a dynamic setting can generate positive return autocorrelation that strengthens with borrower riskiness. We use data on U.S. residential mortgages to test the model's main predictions, for which we find strong empirical support. 

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