Lenders are frequently accused of mispricing the put option imbedded in non-recourse lending (Herring and Wachter, 1999 and 2003). Prior research (Pavlov and Wachter, 2004) shows one lender's incentives to underprice. Here we identify the conditions for a market-wide underpricing equilibrium. We...

Mortgage-backed securities (MBS) funded the U.S. housing bubble, while the ensuing bust resulted in systemic risk and the global financial crisis of 2007-09. In the run-up to the crisis, MBS pricing failed to reveal the growing credit risk. This article draws lessons from this failure that could...