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Transaction Costs, Suboptimal Termination and Default Probabilities

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  • James B. Kau
  • Donald C. Keenan
  • Taewon Kim

Abstract

The same option-based methodology now commonly used to value mortgages and their termination features also can be applied to calculate the probabilities that mortgage default will occur. This paper pursues that idea, and furthermore, enriches the idealized option-based approach by introducing both transaction costs and "suboptimal" termination. These latter features capture the individual considerations that cause a mortgage holder's actions to differ from what rationality would indicate based solely on the market value of the mortgage. These features are of considerable importance if the results of options-based models are to be made comparable to those calculations of default probabilities occurring in the empirical literature. Copyright American Real Estate and Urban Economics Association.

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Bibliographic Info

Article provided by American Real Estate and Urban Economics Association in its journal Real Estate Economics.

Volume (Year): 21 (1993)
Issue (Month): 3 ()
Pages: 247-263

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Handle: RePEc:bla:reesec:v:21:y:1993:i:3:p:247-263

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Cited by:
  1. Danny Ben-Shahar, 2008. "Default, Credit Scoring, and Loan-to-Value: a Theoretical Analysis under Competitive and Non-Competitive Mortgage Markets," Journal of Real Estate Research, American Real Estate Society, vol. 30(2), pages 161-190.
  2. Brueckner, Jan K. & Calem, Paul S. & Nakamura, Leonard I., 2012. "Subprime mortgages and the housing bubble," Journal of Urban Economics, Elsevier, vol. 71(2), pages 230-243.
  3. Richard Anderson & James VanderHoff, 1999. "Mortgage Default Rates and Borrower Race," Journal of Real Estate Research, American Real Estate Society, vol. 18(2), pages 279-290.
  4. Tsai, Ming-Shann & Liao, Szu-Lang & Chiang, Shu-Ling, 2009. "Analyzing yield, duration and convexity of mortgage loans under prepayment and default risks," Journal of Housing Economics, Elsevier, vol. 18(2), pages 92-103, June.
  5. George H. Lentz & Ko Wang, 1998. "Residential Appraisal and the Lending Process: A Survey of Issues," Journal of Real Estate Research, American Real Estate Society, vol. 15(1), pages 11-40.
  6. Danny Ben-Shahar, 2006. "Screening Mortgage Default Risk: A Unified Theoretical Framework," Journal of Real Estate Research, American Real Estate Society, vol. 28(3), pages 215-240.
  7. Ozgur Emre Ergungor, 2007. "Foreclosures in Ohio: does lender type matter?," Working Paper 0724, Federal Reserve Bank of Cleveland.
  8. Goodman, Allen C. & Smith, Brent C., 2010. "Residential mortgage default: Theory works and so does policy," Journal of Housing Economics, Elsevier, vol. 19(4), pages 280-294, December.
  9. Gerardi, Kristopher & Herkenhoff, Kyle F. & Ohanian, Lee E. & Willen, Paul S., 2013. "Unemployment, negative equity, and strategic default," Working Paper 2013-04, Federal Reserve Bank of Atlanta.
  10. Eddie Lam, 2002. "A Risk Management Model for MBS Issuers," International Real Estate Review, Asian Real Estate Society, vol. 5(1), pages 169-195.
  11. Allen C. Goodman & Brent C. Smith, 2010. "Housing default: theory works and so does policy," Working Paper 10-10, Federal Reserve Bank of Richmond.
  12. Russell Kashian & David Welsch, 2008. "A Regional Examination of Foreclosures," Working Papers 08-04, UW-Whitewater, Department of Economics.
  13. Seow Ong & Tien Sing & Alan Teo, 2007. "Delinquency and Default in Arms: The Effects of Protected Equity and Loss Aversion," The Journal of Real Estate Finance and Economics, Springer, vol. 35(3), pages 253-280, October.

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