Adverse selection and the market for building society mortgage finance

This study investigates the possibility of adverse selection in the U.K. mortgage market. Long- and short-run equations for the supply and demand for building society net advances are estimated using the Johansen procedure and three-stage least squares. We identify a long-run backward-bending mortgage supply curve with a bank-optimal nominal mortgage rate of 11.86 per cent, and from the cointegrating vectors we are able to estimate good error-correction representations of supply and demand using three-stage least squares. We find that the adjustment of supply and demand towards their long-run equilibrium values is fairly slow.