Public and Private Benefits of Information in Markets for Securitized Assets

I investigate the tension between screening and adverse selection in markets where bank assets can be resold, such as the secondary market for residential mortgages in the U.S., via a non-cooperative, two-player game. Information acquisition is costly to a Bank and is hidden from a Purchaser. The key tradeoff is between the origination of higher-quality assets, the “public” benefit of information, and the potential for the Bank to adversely select which assets to offer for sale, the “private” (to the lender) benefit of information. If the Purchaser observes a proxy for screening costs, such as geographic distance between lenders and borrowers, then it can exert market discipline: when the private benefit of information exceeds the public benefit, markets operate in a low-information equilibrium, and vice versa.