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Residential mortgage default: the roles of house price volatility, euphoria and the borrower's put option

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  • Wayne R. Archer
  • Brent C. Smith

Abstract

House price volatility; lender and borrow perception of price trends, loan and property features; and the borrower?s put option are integrated in a model of residential mortgage default. These dimensions of the default problem have, to our knowledge, not previously been considered altogether within the same investigation framework. We rely on a sample of individual mortgage loans for twenty counties in Florida, over the period 2001 through 2008, third quarter, with housing price performance obtained from repeat sales analysis of individual transactions. The results from the analysis strongly confirm the significance of the borrower?s put as an operative factor in default. At the same time, the results provide convincing evidence that the experience in Florida is in part driven by lenders and purchasers exhibiting euphoric behavior such that in markets with higher price appreciation there is a willingness to accept recent prior performance as an indicator of future risk. This connection illustrates a familiar moral hazard in the housing market due to the limited information about future prices.

Suggested Citation

  • Wayne R. Archer & Brent C. Smith, 2010. "Residential mortgage default: the roles of house price volatility, euphoria and the borrower's put option," Working Paper 10-02, Federal Reserve Bank of Richmond.
  • Handle: RePEc:fip:fedrwp:10-02
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    Cited by:

    1. Brent Smith, 2012. "Lending Through the Cycle: The Federal Housing Administration’s Evolving Risk in the Primary Market," Atlantic Economic Journal, Springer;International Atlantic Economic Society, vol. 40(3), pages 253-271, September.

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    Keywords

    Housing ; Pricing;

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