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Stochastic House Appreciation and Optimal Mortgage Lending

Author

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  • Tomasz Piskorski
  • Alexei Tchistyi

Abstract

We characterize the optimal mortgage contract in a continuous-time setting with stochastic growth in house price and income, costly foreclosure, and a risky borrower who requires incentives to repay his debt. We show that many features of subprime loans can be consistent with properties of the optimal contract and that, when house prices decline, mortgage modification can create value for borrowers and lenders. Our model provides a number of empirical predictions that relate the features of mortgage contracts originated in a housing boom and the extent of their modification in a slump to location and borrowers' characteristics. The Author 2011. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.

Suggested Citation

  • Tomasz Piskorski & Alexei Tchistyi, 2011. "Stochastic House Appreciation and Optimal Mortgage Lending," Review of Financial Studies, Society for Financial Studies, vol. 24(5), pages 1407-1446.
  • Handle: RePEc:oup:rfinst:v:24:y:2011:i:5:p:1407-1446
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    File URL: http://hdl.handle.net/10.1093/rfs/hhq152
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    Citations

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    Cited by:

    1. Noah Williams & Rui Li, 2014. "Optimal Unemployment Insurance and Cyclical Fluctuations," 2014 Meeting Papers 804, Society for Economic Dynamics.
    2. repec:hrv:faseco:30758219 is not listed on IDEAS
    3. Mayer, Chris & Piskorski, Tomasz & Tchistyi, Alexei, 2013. "The inefficiency of refinancing: Why prepayment penalties are good for risky borrowers," Journal of Financial Economics, Elsevier, vol. 107(3), pages 694-714.
    4. Fang, Hanming & Kim, You Suk & Li, Wenli, 2016. "The dynamics of subprime adjustable-rate mortgage default: a structural estimation," Working Papers 16-2, Federal Reserve Bank of Philadelphia.
    5. Hedlund, Aaron, 2016. "Illiquidity and its discontents: Trading delays and foreclosures in the housing market," Journal of Monetary Economics, Elsevier, vol. 83(C), pages 1-13.
    6. Sumit Agarwal & Gene Amromin & Itzhak Ben-David & Souphala Chomsisengphet & Tomasz Piskorski & Amit Seru, 2017. "Policy Intervention in Debt Renegotiation: Evidence from the Home Affordable Modification Program," Journal of Political Economy, University of Chicago Press, vol. 125(3), pages 654-712.
    7. Christopher Mayer & Edward Morrison & Tomasz Piskorski & Arpit Gupta, 2014. "Mortgage Modification and Strategic Behavior: Evidence from a Legal Settlement with Countrywide," American Economic Review, American Economic Association, vol. 104(9), pages 2830-2857, September.
    8. repec:eee:mateco:v:71:y:2017:i:c:p:74-91 is not listed on IDEAS
    9. Brett Green & Curtis R. Taylor, 2016. "Breakthroughs, Deadlines, and Self-Reported Progress: Contracting for Multistage Projects," American Economic Review, American Economic Association, vol. 106(12), pages 3660-3699, December.
    10. John Y. Campbell, 2013. "Mortgage Market Design," Review of Finance, European Finance Association, vol. 17(1), pages 1-33.
    11. Martin Szydlowski, 2012. "Ambiguity in Dynamic Contracts," Discussion Papers 1543, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    12. Jack Favilukis & Sydney C. Ludvigson & Stijn Van Nieuwerburgh, 2017. "The Macroeconomic Effects of Housing Wealth, Housing Finance, and Limited Risk Sharing in General Equilibrium," Journal of Political Economy, University of Chicago Press, vol. 125(1), pages 140-223.
    13. Halket, Jonathan R & Pignatti, Matteo, 2012. "Housing tenure choices with private information," Economics Discussion Papers 8961, University of Essex, Department of Economics.
    14. Furlong, Frederick T. & Takhtamanova, Yelena & Lang, David, 2016. "Mortgage Choice: Interactive Effects of House Price Appreciation and Mortgage Pricing Components," Working Paper Series 2016-28, Federal Reserve Bank of San Francisco.
    15. Tomasz Piskorski & Alexei Tchistyi, 2017. "An Equilibrium Model of Housing and Mortgage Markets with State-Contingent Lending Contracts," NBER Working Papers 23452, National Bureau of Economic Research, Inc.
    16. James A. Kahn, 2008. "What drives housing prices?," Staff Reports 345, Federal Reserve Bank of New York.
    17. Benjamin J. Keys & Tomasz Piskorski & Amit Seru & Vikrant Vig, 2012. "Mortgage Financing in the Housing Boom and Bust," NBER Chapters,in: Housing and the Financial Crisis, pages 143-204 National Bureau of Economic Research, Inc.
    18. Halket, Jonathan & Pignatti Morano di Custoza, Matteo, 2015. "Homeownership and the scarcity of rentals," Journal of Monetary Economics, Elsevier, vol. 76(C), pages 107-123.

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