Stochastic House Appreciation and Optimal Mortgage Lending
Assuming full rationality, we characterize the optimal mortgage contract in a continuous time setting with a risky borrower, costly default, a moral hazard problem between the borrower and the lender, and a stochastic house appreciation. We show that many features of subprime lending observed in practice are consistent with economic e¢ ciency and rationality of both borrowers and lenders. In particular, preferential treatment of subprime borrowers is optimal during the housing boom, while default clustering among subprime borrowers is optimal during the housing slump. We also find that stochastic house appreciation makes it profitable to give loans to subprime borrowers who otherwise would be shut out of the housing market, which generates substantial ex-ante utility gains for these borrowers.
|Date of creation:||2008|
|Date of revision:|
|Contact details of provider:|| Postal: Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA|
Web page: http://www.EconomicDynamics.org/society.htm
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Kau, James B, et al, 1992. "A Generalized Valuation Model for Fixed-Rate Residential Mortgages," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 24(3), pages 279-99, August.
- John Campbell & Joao F. Cocco, 2002.
"Household Risk Management and Optimal Mortgage Choice,"
Computing in Economics and Finance 2002
47, Society for Computational Economics.
- John Y. Campbell & João F. Cocco, 2003. "Household Risk Management and Optimal Mortgage Choice," The Quarterly Journal of Economics, Oxford University Press, vol. 118(4), pages 1449-1494.
- John Y. Campbell & Joao F. Cocco, 2003. "Household Risk Management and Optimal Mortgage Choice," NBER Working Papers 9759, National Bureau of Economic Research, Inc.
- Joao Cocco & John Campbell, 2004. "Household Risk Management and Optimal Mortgage Choice," Econometric Society 2004 North American Winter Meetings 632, Econometric Society.
- John Y. Campbell & Joao F. Cocco, 2002. "Household Risk Management and Optimal Mortgage Choice," Harvard Institute of Economic Research Working Papers 1946, Harvard - Institute of Economic Research.
- Joao Cocco & John Campbell, 2004. "Household Risk Management and Optimal Mortgage Choice," Econometric Society 2004 North American Winter Meetings 646, Econometric Society.
- Campbell, John & Cocco, Joao, 2003. "Household Risk Management and Optimal Mortgage Choice," Scholarly Articles 3157876, Harvard University Department of Economics.
- Yacine Ait-Sahalia & Jonathan A. Parker & Motohiro Yogo, 2002.
"Luxury Goods and the Equity Premium,"
145, Princeton University, Woodrow Wilson School of Public and International Affairs, Discussion Papers in Economics.
- Biais, Bruno & Mariotti, Thomas & Plantin, Guillaume & Rochet, Jean-Charles, 2004.
"Dynamic Security Design: Convergence to Continuous Time and Asset Pricing Implications,"
IDEI Working Papers
312, Institut d'Économie Industrielle (IDEI), Toulouse, revised Sep 2006.
- Bruno Biais & Thomas Mariotti & Guillaume Plantin & Jean-Charles Rochet, 2007. "Dynamic Security Design: Convergence to Continuous Time and Asset Pricing Implications," Review of Economic Studies, Oxford University Press, vol. 74(2), pages 345-390.
- Christopher Phelan & Robert M. Townsend, 1991. "Computing Multi-Period, Information-Constrained Optima," Review of Economic Studies, Oxford University Press, vol. 58(5), pages 853-881.
- LeRoy, Stephen F, 1996. "Mortgage Valuation under Optimal Prepayment," Review of Financial Studies, Society for Financial Studies, vol. 9(3), pages 817-44.
- Posey, Lisa L. & Yavas, Abdullah, 2001. "Adjustable and Fixed Rate Mortgages as a Screening Mechanism for Default Risk," Journal of Urban Economics, Elsevier, vol. 49(1), pages 54-79, January.
- Stephen E. Spear & Sanjay Srivastava, 1987. "On Repeated Moral Hazard with Discounting," Review of Economic Studies, Oxford University Press, vol. 54(4), pages 599-617.
- Richard Stanton & Nancy Wallace, 1998. "Mortgage Choice: What's the Point?," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 26(2), pages 173-205.
- Chari, V V & Jagannathan, Ravi, 1989. " Adverse Selection in a Model of Real Estate Lending," Journal of Finance, American Finance Association, vol. 44(2), pages 499-508, June.
- Dunn, Kenneth B & Spatt, Chester S, 1985. " An Analysis of Mortgage Contracting: Prepayment Penalties and the Due-on-Sale Clause," Journal of Finance, American Finance Association, vol. 40(1), pages 293-308, March.
- Sumit Agarwal & Calvin T. Ho, 2007. "Comparing the prime and subprime mortgage markets," Chicago Fed Letter, Federal Reserve Bank of Chicago, issue Aug.
- Peter M. DeMarzo & Michael J. Fishman, 2007. "Agency and Optimal Investment Dynamics," Review of Financial Studies, Society for Financial Studies, vol. 20(1), pages 151-188, January.
When requesting a correction, please mention this item's handle: RePEc:red:sed008:938. 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: (Christian Zimmermann)
If references are entirely missing, you can add them using this form.