Mortgage Terminations, Heterogeneity, and the Exercise of Mortgage Options
As applied to the behavior of homeowners with mortgages, option theory predicts that mortgage prepayment or default will be exercised if the call or put option in "in the money" by some specific amount. Our analysis: tests the extent to which the option approach can explain default and prepayment behavior; evaluates the practical importance of modeling both options simultaneously; and models the unobserved herterogeneity of borrowers in the home mortgage market. The paper presents a unified model of the competing risks of mortgage termination by prepayment and default, considering the two hazards as dependent competing risks which are estimated jointly. It also accounts for the unobserved heterogeneity among borrowers, and estimates the unobserved heterogeneity simultaneously with the parameters and baseline hazards associated with prepayment and default functions. Our results show that the option model, in its most straightforward version, does a good job of explaining default and prepayment; but it is not enough by itself. The simultaneity of the options is very important empirically in explaining behavior. The results also show that there exists significant heterogeneity among mortgage borrowers. Ignoring this heterogeneity results in serious errors in estimating the prepayment behavior of homeowners.
|Date of creation:||01 Feb 1999|
|Date of revision:|
|Contact details of provider:|| Postal: |
Phone: (510) 642-1922
Fax: (510) 642-5018
Web page: http://www.escholarship.org/repec/iber_bphup/Email:
More information through EDIRC
When requesting a correction, please mention this item's handle: RePEc:cdl:bphupl:qt96r560pg. 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: (Lisa Schiff)
If references are entirely missing, you can add them using this form.