Liquidity Contractions and Prepayment Risk on Collateralized Asset Markets
AbstractThis paper presents a dynamic general equilibrium model with default and collateral requirements. In contrast with previous literature, our model allows for liquidity contractions and general prepayment specifications. We show that liquidity substantially affects credit and prepayment risks, and that different borrowers may follow differentiated payment strategies: whereas some pay, others prepay or default. The lack of liquidity increases debtors' willingness to continue paying, even thought prepayment cost could be higher than the collateral value. This mechanism rationalizes underwater mortgages. We prove existence of equilibrium, and provide a numerical example illustrating the main determinants of optimal payment strategies.
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Bibliographic InfoPaper provided by University of Chile, Department of Economics in its series Working Papers with number wp364.
Length: 22 pages
Date of creation: Sep 2012
Date of revision:
Other versions of this item:
- Miguel Angel Iraola & Juan Pablo Torres-Martinez, 2012. "Liquidity Contractions and Prepayment Risk on Collateralized Asset Markets," Working Papers 1204, Centro de Investigacion Economica, ITAM.
- D50 - Microeconomics - - General Equilibrium and Disequilibrium - - - General
- D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-10-13 (All new papers)
- NEP-DGE-2012-10-13 (Dynamic General Equilibrium)
- NEP-MAC-2012-10-13 (Macroeconomics)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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