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A Neurological Explanation of Strategic Mortgage Default

Author

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  • Michael Seiler

    ()

  • Eric Walden

    ()

Abstract

This study examines strategic mortgage default on a neurological level. Specifically, we test two mainstream behavioral finance/economic theories: sunk cost fallacy and cognitive dissonance. Using fMRI technology, we identify a number of substrates within the brain that provide a neurobiological explanation for why some homeowners exercise their mortgage put option while others do not. We find that borrowers rationally do not suffer from the sunk cost fallacy as it relates to strategic default in that they significantly prioritize their negative equity position over the amount of their initial down payment. We do, however, find neurological support that cognitive dissonance is relevant in homeowners’ thought processes as they toil with the hesitancy brought on by the believe that strategic default is immoral against the strong financial incentive to walk away from a substantially underwater mortgage. Copyright Springer Science+Business Media New York 2015

Suggested Citation

  • Michael Seiler & Eric Walden, 2015. "A Neurological Explanation of Strategic Mortgage Default," The Journal of Real Estate Finance and Economics, Springer, vol. 51(2), pages 215-230, August.
  • Handle: RePEc:kap:jrefec:v:51:y:2015:i:2:p:215-230
    DOI: 10.1007/s11146-014-9479-7
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    File URL: http://hdl.handle.net/10.1007/s11146-014-9479-7
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    References listed on IDEAS

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    1. Luigi Guiso & Paola Sapienza & Luigi Zingales, 2013. "The Determinants of Attitudes toward Strategic Default on Mortgages," Journal of Finance, American Finance Association, vol. 68(4), pages 1473-1515, August.
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    5. Sandeep Baliga & Jeffrey C. Ely, 2011. "Mnemonomics: The Sunk Cost Fallacy as a Memory Kludge," American Economic Journal: Microeconomics, American Economic Association, vol. 3(4), pages 35-67, November.
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    10. Cary Frydman & Nicholas Barberis & Colin Camerer & Peter Bossaerts & Antonio Rangel, 2014. "Using Neural Data to Test a Theory of Investor Behavior: An Application to Realization Utility," Journal of Finance, American Finance Association, vol. 69(2), pages 907-946, April.
    11. Michael J. Seiler & Vicky L. Seiler & Mark A. Lane & David M. Harrison, 2012. "Fear, Shame and Guilt: Economic and Behavioral Motivations for Strategic Default," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 40, pages 199-233, December.
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    More about this item

    Keywords

    Neurological real estate; Forensic real estate; fMRI; Strategic mortgage default; C91; D81; G02; R39;

    JEL classification:

    • C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G02 - Financial Economics - - General - - - Behavioral Finance: Underlying Principles
    • R39 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Real Estate Markets, Spatial Production Analysis, and Firm Location - - - Other

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