Automated Underwriting and the Profitability of Mortgage Securitization

This paper develops a game‐theoretic model of mortgage securitization, which is then used to examine a potential effect of automated underwriting. The paper's primary supposition is that automated underwriting lowers the costs to competitive mortgage originators and a monopolist securitizer of identifying mortgage applicants who are good credit risks. Faced with lower underwriting costs, originators will screen a larger number of mortgage applicants in the hopes of holding more good risks in their portfolios and passing through more bad risks to the securitizer. This mounting adverse‐selection problem causes the securitizer's expected revenues to decline; this effect can outweigh the cost‐saving benefit of automated underwriting, causing the securitizer's return on equity to fall.