Subprime Mortgage Default

Posted: 28 Apr 2010 Last revised: 4 Jun 2010

See all articles by James B. Kau

James B. Kau

University of Georgia - Department of Insurance, Legal Studies, Real Estate

Donald C. Keenan

University of Cergy-Pontoise; University of Georgia

Constantine Lyubimov

Federal National Mortgage Association (Fannie Mae)

V. Carlos Slawson, Jr.

Louisiana State University

Date Written: March 23, 2010

Abstract

Using data on privately-securitized subprime ARMs (adjustable rate mortgages) originated between 1997 and 2008 and observed between 2000 and 2008, and so covering the start of the subprime crisis, this paper constructs a reduced-form credit risk model of default, and then uses contractual properties of the loans to infer the market’s price of default risk at various times of origination.

Treating the hazard of default as a process rather than a single realization for each period of origination permits the probability of default to be calculated without knowledge of the still unfolding hazard realization, allowing one to adopt the same position as lenders, who also cannot foretell the future. It is empirically determined that a change in the inherent nature of borrowers caused some deterioration in their default behavior, a change which we can first detect by late 2004, but of which, evidence indicates, the secondary mortgage market became aware at about the same time. The large rise in defaults in 2007 cannot, therefore, be attributed to any surprise other than the unexpectedly large fall in housing prices.

Keywords: Mortgage, subprime, reduced-form valuation

JEL Classification: C15, C41, D12

Suggested Citation

Kau, James B. and Keenan, Donald C. and Lyubimov, Constantine and Slawson, Jr., V. Carlos, Subprime Mortgage Default (March 23, 2010). Available at SSRN: https://ssrn.com/abstract=1596202 or http://dx.doi.org/10.2139/ssrn.1596202

James B. Kau

University of Georgia - Department of Insurance, Legal Studies, Real Estate ( email )

Athens, GA 30602-6254
United States
706-542-9110 (Phone)
706-542-4295 (Fax)

Donald C. Keenan

University of Cergy-Pontoise ( email )

33 Boulevard du Port
Cergy-Pontoise Cedex, Cedex 95011
France

University of Georgia ( email )

510 Brooks Hall
Athens, GA 30602
United States
706-542-3668 (Phone)

Constantine Lyubimov (Contact Author)

Federal National Mortgage Association (Fannie Mae) ( email )

3900 Wisconsin Avenue, NW
Washington, DC 20016-2892
United States

V. Carlos Slawson, Jr.

Louisiana State University ( email )

E. J. Ourso College of Business
Department of Finance
Baton Rouge, LA 70803-6308
United States
225-578-6291 (Phone)

HOME PAGE: http://www.lsu.edu/business/finance/profile-viewer.php?un=cslawson

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