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A model of mortgage default

  • Campbell, John Y.
  • Cocco, João F.

This paper solves a dynamic model of households' mortgage decisions incorporating labor income, house price, inflation, and interest rate risk. It uses a zero-profit condition for mortgage lenders to solve for equilibrium mortgage rates given borrower characteristics and optimal decisions. The model quantifies the effects of adjustable vs. fixed mortgage rates, loan-to-value ratios, and mortgage affordability measures on mortgage premia and default. Heterogeneity in borrowers' labor income risk is important for explaining the higher default rates on adjustable-rate mortgages during the recent US housing downturn, and the variation in mortgage premia with the level of interest rates.

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Paper provided by Center for Financial Studies (CFS) in its series CFS Working Paper Series with number 452.

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Date of creation: 2014
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Handle: RePEc:zbw:cfswop:452
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