Analysis Of Discrimination In Prime And Subprime Mortgage Markets

This paper examines lending discrimination in prime and subprime mortgage markets. The recent development of the subprime mortgage lending market allows them to examine implications of the taste-based and information-based theories of discrimination in an important asset class, namely, residential real estate. The existing single equation studies on race-based discrimination in mortgage lending assume race is uncorrelated with the disturbance term in the loan denial regression. At the individual loan-level, the authors show that race is correlated with both observable and unobservable risk variables and is therefore correlated with the disturbance term. To rectify this problem they specify a system of equations and use a novel econometric technique (Full Information Maximum Likelihood) that does not need to identify instrumental variables for system identification.