Mortgage Prepayment and Default Behavior with Embedded Forward Contract Risks in China's Housing Market

39 Pages Posted: 6 Aug 2008

See all articles by Yongheng Deng

Yongheng Deng

Wisconsin School of Business, University of Wisconsin-Madison

Peng Liu

Cornell University - S.C. Johnson College of Business

Multiple version iconThere are 2 versions of this paper

Date Written: August 6, 2008

Abstract

Most condominiums in China are sold forward on a pre-sale market, where purchasers and developers transact on an underlying property that is not yet completed. During the pre-sale period home buyers face a significant forward contract risk. However, home buyers can borrow mortgages from banks so that they can effectively share the forward contract risk with banks. This explains the phenomenon of irregularly high early-stage default and prepayment rates observed in residential mortgage lending in China, where there are few, if any, financial incentives for mortgage borrowers to exercise either put or call options. Mortgages collateralized by forward housing assets are riskier than are those with underlying assets traded on the spot market. However, currently Chinese mortgage banks charge the same rate to all mortgage borrowers. This inefficiency in risk sharing between mortgage borrowers' groups in the forward and spot housing markets leads to mispricing in secondary mortgage sales and mortgage-backed security trading.

Keywords: Mortgage, Prepayment, Default, Credit Risk, Forward Contract, Pre-sale

JEL Classification: G12, G14, G21, H31

Suggested Citation

Deng, Yongheng and Liu, Peng, Mortgage Prepayment and Default Behavior with Embedded Forward Contract Risks in China's Housing Market (August 6, 2008). Available at SSRN: https://ssrn.com/abstract=1207802 or http://dx.doi.org/10.2139/ssrn.1207802

Yongheng Deng

Wisconsin School of Business, University of Wisconsin-Madison ( email )

4110 Grainger Hall
975 University Avenue
Madison, WI 53706
United States
+1 (608) 262-4865 (Phone)

HOME PAGE: http://https://bus.wisc.edu/faculty/yongheng-deng

Peng Liu (Contact Author)

Cornell University - S.C. Johnson College of Business ( email )

448 Statler Hall
Ithaca, NY 14853
United States
6072542960 (Phone)

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