Incentive to Issue Low Quality Securitized Products in the OTD Business Model

We consider an economy where a lender nances his loans to borrowers by issuing a securitized product to an investor and where the credit quality of the product may depend on whether the lender screens the borrowers. In the presence of asymmetric information between the lender and the investor about the credit quality of potential borrowers, overvaluation of the low quality securitized product may occur, which ine ciently induces the lender not to screen the borrowers and hence to issue the securitized product with low credit quality. This is likely to occur when the investor nds it di cult to distinguish the good state from the bad state, or when the seed of recession creeps toward the booming economy. We would like to thank Xavier Freixas, Takeo Hoshi, Javier Suarez, Yoshiaki Ogura, Wako Watanabe and some sta members of the Bank of Japan for their comments in our preparation of this paper. The views expressed in this paper are those of the authors and do not necessarily represent those of the Bank of Japan.