Screen More, Sell Later: Screening and Dynamic Signaling in the Mortgage Market

We develop a dynamic model of asset origination with unobservable screening effort and signaling of loan quality through delayed sale by extending Vanasco (2017). The theory predicts a positive relationship between screening effort and the strength of the signal. We test this central prediction using U.S. mortgage data, measuring screening effort by mortgage processing time. Consistent with the theory, loans that take longer to process are sold with longer delay and are less likely to default, even though observably riskier loans are processed more slowly. Our calibration reveals that the subprime mortgage market operated in a parameter range with endogenous fragility. Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.