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Research Seminars & Workshops @ IRES


Mr Alan Feng
Princeton University

Bank Competition, Risk Taking and Their Consequences: Evidence from the U.S. Mortgage and Labor Markets


Date:

26 Jan 2015 (Mon)

Time:

2.30 - 4.00pm

Venue:

SDE1, Level 3, School Conference Room


Abstract

Bank competition can induce excessive risk taking due to risk shifting. With a competitive banking sector and insured deposits, banks may have the incentive to overly invest in risky assets. In this paper, I test this hypothesis using micro-level data in the U.S. mortgage market over the past housing cycle by studying how banks made mortgage lending decisions when subject to uncertainties in the local house price. Using geography-based housing supply elasticity (Saiz (2010)) as an instrument for local house price volatility, I find that, prior to the crisis from 2000 to 2005, banks in U.S. counties with a competitive mortgage market substantially lowered lending standards in response to high volatility in the house price, by twice as much as those in concentrated markets. Moreover, the effect of local competition was particularly strong for lending decisions made by small and regional banks, but was insignificant for national banks. Such risk taking pattern implied real economic consequences after the crisis. In counties where mortgage market was competitive, volatility in house price in the past housing cycle became more damaging: one standard-deviation increase in local house price volatility was associated with 1% higher foreclosure rate and 1.5% higher real-sector unemployment rate after the crisis; none for concentrated mortgage markets. The findings in this study suggest that competition among banks in the mortgage market was strongly associated with both the buildup of house price risk in the banking sector prior to the crisis and the adverse real economic impact after the crisis.

About the Speaker

Xiaochen (Alan) is a 5th-year economics PhD student at Princeton University. His research focuses on empirical macroeconomics and finance. He is on the job market this year and will be available for interview during the ASSA meeting on January 2-5 in Boston, MA. Before coming to Princeton, Xiaochen (Alan) received B.Sc. degree in Computer Science and Mathematics (double major) from the Hong Kong University of Science and Technology.

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