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Unemloyment and Unobserved Credit Risk in the FHA Single Family Mortgage Insurance Fund

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  • Joseph Gyourko
  • Joseph Tracy

Abstract

Empirical 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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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 18880.

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Date of creation: Mar 2013
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Handle: RePEc:nbr:nberwo:18880

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  1. Kau James B. & Keenan Donald C. & Kim Taewon, 1994. "Default Probabilities for Mortgages," Journal of Urban Economics, Elsevier, vol. 35(3), pages 278-296, May.
  2. Andrew Caplin & Anna Cororaton & Joseph Tracy, 2012. "Is the FHA Creating Sustainable Homeownership?," NBER Working Papers 18190, National Bureau of Economic Research, Inc.
  3. Fernando Ferreira & Joseph Gyourko & Joseph Tracy, 2008. "Housing busts and household mobility," Staff Reports, Federal Reserve Bank of New York 350, Federal Reserve Bank of New York.
  4. Fernando Ferreira & Joseph Gyourko & Joseph Tracy, 2011. "Housing Busts and Household Mobility: An Update," NBER Working Papers 17405, National Bureau of Economic Research, Inc.
  5. Yongheng Deng & John M. Quigley & Robert Van Order, 2000. "Mortgage Terminations, Heterogeneity and the Exercise of Mortgage Options," Econometrica, Econometric Society, Econometric Society, vol. 68(2), pages 275-308, March.
  6. Foote, Christopher L. & Gerardi, Kristopher & Willen, Paul S., 2008. "Negative equity and foreclosure: Theory and evidence," Journal of Urban Economics, Elsevier, vol. 64(2), pages 234-245, September.
  7. Caplin, Andrew & Freeman, Charles & Tracy, Joseph, 1997. "Collateral Damage: Refinancing Constraints and Regional Recessions," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 29(4), pages 496-516, November.
  8. Andra C. Ghent & Marianna Kudlyak, 2010. "Recourse and residential mortgage default: theory and evidence from U.S. states," Working Paper, Federal Reserve Bank of Richmond 09-10, Federal Reserve Bank of Richmond.
  9. Moulton, Brent R, 1990. "An Illustration of a Pitfall in Estimating the Effects of Aggregate Variables on Micro Unit," The Review of Economics and Statistics, MIT Press, vol. 72(2), pages 334-38, May.
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Cited by:
  1. Patrick Bayer & Fernando Ferreira & Stephen L. Ross, 2014. "The Vulnerability of Minority Homeowners in the Housing Boom and Bust," Working Papers, Becker Friedman Institute for Research In Economics 2014-006, Becker Friedman Institute for Research In Economics.
  2. Gerardi, Kristopher & Herkenhoff, Kyle F. & Ohanian, Lee E. & Willen, Paul S., 2013. "Unemployment, negative equity, and strategic default," Working Paper, Federal Reserve Bank of Atlanta 2013-04, Federal Reserve Bank of Atlanta.

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