Unemloyment and Unobserved Credit Risk in the FHA Single Family Mortgage Insurance Fund
AbstractEmpirical models of mortgage default typically find that the influence of unemployment is negligible compared to other well known risk factors such as high borrower leverage or low borrower FICO scores. This is at odds with theory, which assigns a critical role to unemployment status in the decision to stop payment on a mortgage. We help reconcile this divergence by employing a novel empirical strategy involving simulated unemployment histories to measure the severity of attenuation bias in loan-level estimations of default risk due to a borrower becoming unemployed. Attenuation bias results because individual data on unemployment status is unobserved, requiring that a market-wide unemployment rate be used as a proxy. Attenuation is extreme, with our results suggesting that the use of an aggregate unemployment rate in lieu of actual borrower unemployment status results in default risk from a borrower becoming unemployed being underestimated by a factor of 100 or more. Correcting for this indicates unemployment is more powerful than other well-known factors such as extremely high leverage or extremely low FICO scores in predicting individual borrower default. Our simulated data indicate that adding the unemployment rate as a proxy for the missing borrower-specific unemployment indicator does not improve the accuracy of the estimated model over the specification without the proxy variable included.
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Bibliographic InfoPaper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 18880.
Date of creation: Mar 2013
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- G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation
- R48 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Transportation Systems - - - Government Pricing and Policy
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- NEP-ALL-2013-03-16 (All new papers)
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- Kristopher Gerardi & Kyle F. Herkenhoff & Lee E. Ohanian & Paul S. Willen, 2013. "Unemployment, negative equity, and strategic default," Working Paper 2013-04, Federal Reserve Bank of Atlanta.
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