Residential Mortgage Default: The Roles of House Price Volatility, Euphoria and the Borrower’s Put Option

43 Pages Posted: 7 Jan 2010

See all articles by Wayne R. Archer

Wayne R. Archer

University of Florida - Warrington College of Business Administration

Brent C. Smith

Virginia Commonwealth University

Date Written: January 6, 2010

Abstract

House price volatility; lender and borrower 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.

Keywords: residential mortgage default, risk, lending, housing economics, mortgage underwriting

JEL Classification: G21, R11, R2, R21

Suggested Citation

Archer, Wayne R. and Smith, Brent C., Residential Mortgage Default: The Roles of House Price Volatility, Euphoria and the Borrower’s Put Option (January 6, 2010). Available at SSRN: https://ssrn.com/abstract=1532224 or http://dx.doi.org/10.2139/ssrn.1532224

Wayne R. Archer

University of Florida - Warrington College of Business Administration ( email )

Gainesville, FL 32611
United States
352-392-1330 (Phone)
352-392-0301 (Fax)

Brent C. Smith (Contact Author)

Virginia Commonwealth University ( email )

1015 Floyd Avenue
Richmond, VA 23284
United States

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