Makarov is with London Business School and Plantin is with Toulouse School of Economics. We thank the Editor (Cam Harvey), an anonymous referee, Andrea Buffa, Joao Cocco, Harold Cole, Bernard Dumas, Stéphane Guibaud, Atif Mian, Tomasz Piskorski, Nagpurnanand Prabhala, Oleg Rytchkov, Andrei Shleifer, Harald Uhlig, Vikrant Vig, and seminar participants at Berkeley, Columbia, The Federal Reserve Bank of Richmond, Free University of Brussels, Hautes Etudes Commerciales Lausanne, Kellogg, London Business School, Princeton, Toulouse School of Economics, The Financial Intermediation Research Society Conference 2010 (Florence), the ESSET 2009 meetings (Gerzensee), the NBER Asset Pricing 2009 Stanford meetings, the North American Econometric Society 2009 Boston meetings, the Society for Economic Dynamics 2009 Istanbul meetings, and the Western Finance Association 2009 San Diego meetings for very helpful comments.
Equilibrium Subprime Lending
Article first published online: 20 MAY 2013
© 2013 the American Finance Association
The Journal of Finance
Volume 68, Issue 3, pages 849–879, June 2013
How to Cite
MAKAROV, I. and PLANTIN, G. (2013), Equilibrium Subprime Lending. The Journal of Finance, 68: 849–879. doi: 10.1111/jofi.12022
- Issue published online: 20 MAY 2013
- Article first published online: 20 MAY 2013
- Accepted manuscript online: 30 JAN 2013 12:35PM EST
- Manuscript Accepted: 30 NOV 2012
- Manuscript Received: 10 DEC 2009
This paper develops an equilibrium model of a subprime mortgage market. Our goal is to offer a benchmark with which the recent subprime boom and bust can be compared. The model is tractable and delivers plausible orders of magnitude for borrowing capacities, as well as default and trading intensities. We offer simple explanations for several phenomena in the subprime market, such as the prevalence of teaser rates and the clustering of defaults. In our model, both nondiversifiable and diversifiable income risks reduce debt capacities. Thus, debt capacities need not be higher when a larger fraction of income risk is diversifiable.