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Mortgage default and mortgage valuation


  • John Krainer
  • Stephen F. LeRoy
  • Munpyung O


We study optimal exercise by mortgage borrowers of the option to default. Also, we use an equilibrium valuation model incorporating default to show how mortgage yields and lender recovery rates on defaulted mortgages depend on initial loan-to-value ratios when borrowers default optimally. The analysis treats both the frictionless case and the case in which borrowers and/or lenders incur deadweight costs upon default. The model is calibrated using data on California mortgages. We find that the model's principal testable implication for default and mortgage pricing—that default rates and yield spreads will be higher for high loan-to-value mortgages—is borne out empirically.

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  • John Krainer & Stephen F. LeRoy & Munpyung O, 2009. "Mortgage default and mortgage valuation," Working Paper Series 2009-20, Federal Reserve Bank of San Francisco.
  • Handle: RePEc:fip:fedfwp:2009-20

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    References listed on IDEAS

    1. Atif Mian & Amir Sufi, 2008. "The Consequences of Mortgage Credit Expansion: Evidence from the 2007 Mortgage Default Crisis," NBER Working Papers 13936, National Bureau of Economic Research, Inc.
    2. Kristopher S. Gerardi & Adam Hale Shapiro & Paul S. Willen, 2007. "Subprime outcomes: risky mortgages, homeownership experiences, and foreclosures," Working Papers 07-15, Federal Reserve Bank of Boston.
    3. Yongheng Deng & John M. Quigley & Robert Van Order, 2000. "Mortgage Terminations, Heterogeneity and the Exercise of Mortgage Options," Econometrica, Econometric Society, vol. 68(2), pages 275-308, March.
    4. Chris Downing & Richard Stanton & Nancy Wallace, 2005. "An Empirical Test of a Two-Factor Mortgage Valuation Model: How Much Do House Prices Matter?," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 33(4), pages 681-710, December.
    5. Kristopher Gerardi & Andreas Lehnert & Shane M. Sherlund & Paul Willen, 2008. "Making Sense of the Subprime Crisis," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 39(2 (Fall)), pages 69-159.
    6. Mark Doms & Frederick T. Furlong & John Krainer, 2007. "Subprime mortgage delinquency rates," Working Paper Series 2007-33, Federal Reserve Bank of San Francisco.
    7. Marjorie Flavin & Takashi Yamashita, 2002. "Owner-Occupied Housing and the Composition of the Household Portfolio," American Economic Review, American Economic Association, vol. 92(1), pages 345-362, March.
    8. Coleman IV, Major & LaCour-Little, Michael & Vandell, Kerry D., 2008. "Subprime lending and the housing bubble: Tail wags dog?," Journal of Housing Economics, Elsevier, vol. 17(4), pages 272-290, December.
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    Cited by:

    1. Daniel Rösch & Harald Scheule, 2011. "Securitization rating performance and agency incentives," BIS Papers chapters,in: Bank for International Settlements (ed.), Portfolio and risk management for central banks and sovereign wealth funds, volume 58, pages 287-314 Bank for International Settlements.
    2. John Krainer & Stephen F. LeRoy, 2010. "Risky mortgages and mortgage default premiums," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue dec20.
    3. Jeske, Karsten & Krueger, Dirk & Mitman, Kurt, 2013. "Housing, mortgage bailout guarantees and the macro economy," Journal of Monetary Economics, Elsevier, vol. 60(8), pages 917-935.
    4. Winkler, Kay, 2015. "Determining Optimal Macroprudential Instruments," Working Paper Series 4182, Victoria University of Wellington, The New Zealand Institute for the Study of Competition and Regulation.
    5. Glaeser, Edward L. & Nathanson, Charles G., 2015. "Housing Bubbles," Handbook of Regional and Urban Economics, Elsevier.

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    Mortgage loans ; Mortgage loans - California ; Default (Finance);

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