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Stochastic House Appreciation and Optimal Mortgage Lending

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  • Tomasz Piskorski
  • Alexei Tchistyi
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    Abstract

    We characterize the optimal mortgage contract in a continuous-time setting with stochastic growth in house price and income, costly foreclosure, and a risky borrower who requires incentives to repay his debt. We show that many features of subprime loans can be consistent with properties of the optimal contract and that, when house prices decline, mortgage modification can create value for borrowers and lenders. Our model provides a number of empirical predictions that relate the features of mortgage contracts originated in a housing boom and the extent of their modification in a slump to location and borrowers' characteristics. The Author 2011. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.

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    File URL: http://hdl.handle.net/10.1093/rfs/hhq152
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    Bibliographic Info

    Article provided by Society for Financial Studies in its journal Review of Financial Studies.

    Volume (Year): 24 (2011)
    Issue (Month): 5 ()
    Pages: 1407-1446

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    Handle: RePEc:oup:rfinst:v:24:y:2011:i:5:p:1407-1446

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    Cited by:
    1. Sumit Agarwal & Gene Amromin & Itzhak Ben-David & Souphala Chomsisengphet & Tomasz Piskorski & Amit Seru, 2012. "Policy Intervention in Debt Renegotiation: Evidence from the Home Affordable Modification Program," NBER Working Papers 18311, National Bureau of Economic Research, Inc.
    2. John Y. Campbell, 2012. "Mortgage Market Design," NBER Working Papers 18339, National Bureau of Economic Research, Inc.
    3. Jack Favilukis & Sydney C. Ludvigson & Stijn Van Nieuwerburgh, 2010. "The Macroeconomic Effects of Housing Wealth, Housing Finance, and Limited Risk-Sharing in General Equilibrium," NBER Working Papers 15988, National Bureau of Economic Research, Inc.
    4. James A. Kahn, 2008. "What drives housing prices?," Staff Reports 345, Federal Reserve Bank of New York.
    5. Mayer, Chris & Piskorski, Tomasz & Tchistyi, Alexei, 2013. "The inefficiency of refinancing: Why prepayment penalties are good for risky borrowers," Journal of Financial Economics, Elsevier, vol. 107(3), pages 694-714.
    6. Christopher J. Mayer & Edward Morrison & Tomasz Piskorski & Arpit Gupta, 2011. "Mortgage Modification and Strategic Behavior: Evidence from a Legal Settlement with Countrywide," NBER Working Papers 17065, National Bureau of Economic Research, Inc.
    7. Martin Szydlowski, 2012. "Ambiguity in Dynamic Contracts," Discussion Papers 1543, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    8. Benjamin J. Keys & Tomasz Piskorski & Amit Seru & Vikrant Vig, 2012. "Mortgage Financing in the Housing Boom and Bust," NBER Chapters, in: Housing and the Financial Crisis, pages 143-204 National Bureau of Economic Research, Inc.

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