Mortgage Terminations, Heterogeneity and the Exercise of Mortgage Options

Posted: 30 Mar 1999

See all articles by Yongheng Deng

Yongheng Deng

Wisconsin School of Business, University of Wisconsin-Madison

John M. Quigley

University of California, Berkeley, College of Letters & Science, Department of Economics (Deceased); University of California, Berkeley, Haas School of Business, Real Estate Group (Deceased)

Robert Van Order

Federal Home Loan Mortgage Corporation (FHLMC) - Housing Economics and Financial Research

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Abstract

As applied to the behavior of homeowners with mortgages, option theory predicts that mortgage prepayment or default will be exercised if the call or put option is in the money by some specific amount. Our analysis: tests the extent to which the option approach can explain default and prepayment behavior; evaluates the practical importance of modeling both options simultaneously; and models the unobserved heterogeneity of borrowers in the home mortgage market. The paper presents a unified model of the competing risks of mortgage termination by prepayment and default, considering the two hazards as dependent competing risks which are estimated jointly. It also accounts for the unobserved heterogeneity among borrowers, and estimates the unobserved heterogeneity simultaneously with the parameters and baseline hazards associated with prepayment and default functions. Our results show that the option model, in its most straightforward version, does a good job of explaining default and prepayment; but it is not enough by itself. The simultaneity of the options is very important empirically in explaining behavior. The results also show that there exists significant heterogeneity among mortgage borrowers. Ignoring this heterogeneity results in serious errors in estimating the prepayment behavior of homeowners.

JEL Classification: G21, C41, R20

Suggested Citation

Deng, Yongheng and Quigley, John M. and Van Order, Robert, Mortgage Terminations, Heterogeneity and the Exercise of Mortgage Options. Econometrica. Available at SSRN: https://ssrn.com/abstract=157018

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

John M. Quigley (Contact Author)

University of California, Berkeley, College of Letters & Science, Department of Economics (Deceased) ( email )

Berkeley, CA 94720-3880
United States
510-643-7411 (Phone)
510-643-7357 (Fax)

University of California, Berkeley, Haas School of Business, Real Estate Group (Deceased) ( email )

Berkeley, CA 94720-1900
United States

Robert Van Order

Federal Home Loan Mortgage Corporation (FHLMC) - Housing Economics and Financial Research ( email )

Mailstop 484
8200 Jones Branch Drive
McLean, VA 22102
United States
703-903-2390 (Phone)
703-903-2445 (Fax)

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