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Mortgage Prepayment and Default Behavior with Embedded Forward Contract Risks in China’s Housing Market

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  • Yongheng Deng
  • Peng Liu

Abstract

Most condominiums in China are sold forward on a pre-sale market, where purchasers and developers transact on an underlying property that is not yet completed. During the pre-sale period home buyers face a significant forward contract risk. However, home buyers can borrow mortgages from banks so that they can effectively share the forward contract risk with banks. This explains the phenomenon of irregularly high early-stage default and prepayment rates observed in residential mortgage lending in China, where there are few, if any, financial incentives for mortgage borrowers to exercise either put or call options. Mortgages collateralized by forward housing assets are riskier than are those with underlying assets traded on the spot market. However, currently Chinese mortgage banks charge the same rate to all mortgage borrowers. This inefficiency in risk sharing between mortgage borrowers’ groups in the forward and spot housing markets leads to mispricing in secondary mortgage sales and mortgage-backed security trading. Copyright Springer Science+Business Media, LLC 2009

Suggested Citation

  • Yongheng Deng & Peng Liu, 2009. "Mortgage Prepayment and Default Behavior with Embedded Forward Contract Risks in China’s Housing Market," The Journal of Real Estate Finance and Economics, Springer, vol. 38(3), pages 214-240, April.
    • Handle: RePEc:kap:jrefec:v:38:y:2009:i:3:p:214-240
    DOI: 10.1007/s11146-008-9151-1
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    Cited by:

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    2. Wu, Wenjie, 2012. "Does public investment spur the land market?: evidence from transport improvement in Beijing," LSE Research Online Documents on Economics 57918, London School of Economics and Political Science, LSE Library.
    3. Ye, Guangliang & Deng, Guoying & Li, Zhigang, 2014. "Mortgage rate and choice of mortgage length: A quasi-experimental evidence from Chinese transaction-level data," Journal of Housing Economics, Elsevier, vol. 25(C), pages 96-103.
    4. Juanjuan Zhang & Peng Liu, 2012. "Rational Herding in Microloan Markets," Management Science, INFORMS, vol. 58(5), pages 892-912, May.
    5. Weida Kuang & Peng Liu, 2015. "Inflation and House Prices: Theory and Evidence from 35 Major Cities in China," International Real Estate Review, Global Social Science Institute, vol. 18(2), pages 217-240.
    6. Deng, Yongheng & Wu, Jing, 2014. "Economic returns to residential green building investment: The developers' perspective," Regional Science and Urban Economics, Elsevier, vol. 47(C), pages 35-44.
    7. Robert Edelstein & Peng Liu & Fang Wu, 2012. "The Market for Real Estate Presales: A Theoretical Approach," The Journal of Real Estate Finance and Economics, Springer, vol. 45(1), pages 30-48, June.
    8. Quan Gan & Maggie Rong Hu & Wayne Xinwei Wan, 2022. "Contract rescission in the real estate presale market," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 50(4), pages 1054-1106, December.
    9. Wenjie Wu & Guanpeng Dong & Bing Wang, 2015. "Does Planning Matter? Effects on Land Markets," The Journal of Real Estate Finance and Economics, Springer, vol. 50(2), pages 242-269, February.
    10. Deng, Yongheng & Gu, Quanlin & He, Jia, 2021. "Reinforcement learning and mortgage partial prepayment behavior," Pacific-Basin Finance Journal, Elsevier, vol. 68(C).
    11. Peter Chinloy & Zhonghua Wu, 2013. "The Inventory-Sales Ratio and Homebuilder Return Predictability," The Journal of Real Estate Finance and Economics, Springer, vol. 46(3), pages 397-423, April.
    12. Iris Claus & Les Oxley & Jie Chen & Xuehui Han, 2014. "The Evolution Of The Housing Market And Its Socioeconomic Impacts In The Post-Reform People'S Republic Of China: A Survey Of The Literature," Journal of Economic Surveys, Wiley Blackwell, vol. 28(4), pages 652-670, September.
    13. Zheng, Siqi & Wu, Jing & Kahn, Matthew E. & Deng, Yongheng, 2012. "The nascent market for “green” real estate in Beijing," European Economic Review, Elsevier, vol. 56(5), pages 974-984.
    14. L. Li & K. W. Chau, 2019. "What Motivates a Developer to Sell before Completion?," The Journal of Real Estate Finance and Economics, Springer, vol. 59(2), pages 209-232, August.

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    More about this item

    Keywords

    Mortgage; Prepayment; Default; Credit risk; Forward contract; Pre-sale; G12; G14; G21; H31;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • H31 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Household

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