Default, Credit Scoring, and Loan-to-Value: a Theoretical Analysis under Competitive and Non-Competitive Mortgage Markets
Consistent with existing literature, we first show that when borrowers?default probability on the mortgage loan is unobservable to the lender, the latter can screen borrowers by their combined choice of loan-to-value (LTV) ratio and interest rate. We further demonstrate that when borrowers also signal their default risk by acquiring a credit score, then a combined separating signaling and screening equilibrium is attained. If the signaling cost is sufficiently small, the combined signaling and screening equilibrium dominates the screening only equilibrium under both competitive and non-competitive market frameworks. However, while, under the competitive setting, borrowers benefit from constituting a credit scoring signaling system, the prospective gain is shifted to lenders under imperfect competition. Finally, we show that under both competitive and non-competitive combined signaling and screening equilibria, high and low risk borrowers, while acquiring distinct credit scores (and therefore paying different interest rates) might realize higher, lower, or identical LTV ratios. Hence, any empirical test of the relation between LTV ratio and default risk must incorporate the interrelation among the LTV ratio, credit score, and interest rate.
Volume (Year): 30 (2008)
Issue (Month): 2 ()
|Contact details of provider:|| Postal: American Real Estate Society Clemson University School of Business & Behavioral Science Department of Finance 401 Sirrine Hall Clemson, SC 29634-1323|
Web page: http://www.aresnet.org/
|Order Information:|| Postal: Diane Quarles American Real Estate Society Manager of Member Services Clemson University Box 341323 Clemson, SC 29634-1323|
Web: http://pages.jh.edu/jrer/about/get.htm Email:
References listed on IDEAS
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.:
- Dennis R. Capozza & Dick Kazarian & Thomas A. Thomson, 1997. "Mortgage Default in Local Markets," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 25(4), pages 631-655.
- Yongheng Deng & John M. Quigley, 2003.
"Woodhead Behavior and the Pricing of Residential Mortgages,"
8616, USC Lusk Center for Real Estate.
- Deng, Yongheng & Quigley, John M., 2004. "Woodhead Behavior and the Pricing of Residential Mortgages," Berkeley Program on Housing and Urban Policy, Working Paper Series qt85q0w8xj, Berkeley Program on Housing and Urban Policy.
- Neven, Damien & Roller, Lars-Hendrik, 1999. "An aggregate structural model of competition in the European banking industry," International Journal of Industrial Organization, Elsevier, vol. 17(7), pages 1059-1074, October.
- Devereux, Michael P. & Lanot, Gauthier, 2003. "Measuring tax incidence: an application to mortgage provision in the UK," Journal of Public Economics, Elsevier, vol. 87(7-8), pages 1747-1778, August.
- Armstrong, Mark, 2006. "Price discrimination," MPRA Paper 4693, University Library of Munich, Germany.
- Besanko, David & Thakor, Anjan V, 1987. "Collateral and Rationing: Sorting Equilibria in Monopolistic and Competitive Credit Markets," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 28(3), pages 671-689, October.
- Jean-Charles Rochet & Lars A. Stole, 2002. "Nonlinear Pricing with Random Participation," Review of Economic Studies, Oxford University Press, vol. 69(1), pages 277-311.
- Shelagh Heffernan, 1994. "Competition in the Canadian Personal Finance Sector," International Journal of the Economics of Business, Taylor & Francis Journals, vol. 1(3), pages 323-338.
- Gordon W. Crawford & Eric Rosenblatt, 1995. "Efficient Mortgage Default Option Exercise: Evidence from Loss Severity," Journal of Real Estate Research, American Real Estate Society, vol. 10(5), pages 543-556.
- J. Miguel Villas-Boas & Udo Schmidt-Mohr, 1999. "Oligopoly with Asymmetric Information: Differentiation in Credit Markets," RAND Journal of Economics, The RAND Corporation, vol. 30(3), pages 375-396, Autumn.
- James B. Kau & Donald C. Keenan & Taewon Kim, 1993. "Transaction Costs, Suboptimal Termination and Default Probabilities," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 21(3), pages 247-263.
- Gary-Bobo, Robert J. & Larribeau, Sophie, 2004.
"A structural econometric model of price discrimination in the French mortgage lending industry,"
International Journal of Industrial Organization,
Elsevier, vol. 22(1), pages 101-134, January.
- Robert Gary-Bobo & Sophie Larribeau, 2004. "A structural econometric model of price discrimination in the French mortgage lending industry," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) halshs-00068330, HAL.
- Deng, Yongheng & Quigley, John M. & Van Order, Robert & Mac, Freddie, 1996.
"Mortgage default and low downpayment loans: The costs of public subsidy,"
Regional Science and Urban Economics,
Elsevier, vol. 26(3-4), pages 263-285, June.
- Yongheng Deng & John M. Quigley & Robert Van Order, 1995. "Mortgage Default and Low Downpayment Loans: The Costs of Public Subsidy," NBER Working Papers 5184, National Bureau of Economic Research, Inc.
- Vassilis Lekkas & John M. Quigley & Robert Order, 1993. "Loan Loss Severity and Optimal Mortgage Default," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 21(4), pages 353-371.
- Jaffee, Dwight & Stiglitz, Joseph, 1990. "Credit rationing," Handbook of Monetary Economics, in: B. M. Friedman & F. H. Hahn (ed.), Handbook of Monetary Economics, edition 1, volume 2, chapter 16, pages 837-888 Elsevier.
- Brueckner, Jan K, 2000. "Mortgage Default with Asymmetric Information," The Journal of Real Estate Finance and Economics, Springer, vol. 20(3), pages 251-274, May.
- Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June.
- Philip Bond & David K. Musto & Bilge Yilmaz, 2006. "Predatory lending in rational world," Working Papers 06-2, Federal Reserve Bank of Philadelphia.
- Ko Wang & Leslie Young & Yuqing Zhou, 2002. "Nondiscriminating Foreclosure and Voluntary Liquidating Costs," Review of Financial Studies, Society for Financial Studies, vol. 15(3), pages 959-985.
- M. Cary Collins & Keith D. Harvey & Peter J. Nigro, 2002. "The Influence of Bureau Scores, Customized Scores and Judgmental Review on the Bank Underwriting Decision-Making Process," Journal of Real Estate Research, American Real Estate Society, vol. 24(2), pages 129-152.
- Dwight M. Jaffee & Thomas Russell, 1976. "Imperfect Information, Uncertainty, and Credit Rationing," The Quarterly Journal of Economics, Oxford University Press, vol. 90(4), pages 651-666.
- Posey, Lisa L. & Yavas, Abdullah, 2001. "Adjustable and Fixed Rate Mortgages as a Screening Mechanism for Default Risk," Journal of Urban Economics, Elsevier, vol. 49(1), pages 54-79, January.
- Hyytinen, Ari, 2003. "Loan market equilibrium with difference of opinion and imperfect competition," Economics Letters, Elsevier, vol. 78(1), pages 125-129, January.
- Keith D. Harvey & Peter J. Nigro, 2003. "How Do Predatory Lending Laws Influence Mortgage Lending in Urban Areas? A Tale of Two Cities," Journal of Real Estate Research, American Real Estate Society, vol. 25(4), pages 479-508.
When requesting a correction, please mention this item's handle: RePEc:jre:issued:v:30:n:2:2008:p:161-190. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (JRER Graduate Assistant/Webmaster)
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.