The Subprime Virus: Theory and Evidence

36 Pages Posted: 21 May 2010 Last revised: 3 Feb 2011

Sumit Agarwal

National University of Singapore

Brent W. Ambrose

Pennsylvania State University

Yildiray Yildirim

Zicklin School of Business, Baruch College - The City University of New York

Date Written: May 21, 2010

Abstract

We develop a theoretical model demonstrating the potential spillover effects associated with the introduction of risky assets. Specifcally, we examine the potential increase in mortgage default risk on prime mortgages that results from the introduction of subprime mortgages in a local area. The transmission mechanism is that the higher incidence of default by subprime borrowers leads to greater asset price volatility, which in turn impacts the default probability of prime mortgages in the same geographic area. Through numerical analysis, we demonstrate the impact of the origination of subprime mortgages to the risk of a portfolio of prime mortgages. Finally, we offer empirical support for our model by examining the spatial variation in MSA prime mortgage default rates correlated with the level of subprime mortgage activity.

Keywords: Subprime, Default, Portfolio Risk

JEL Classification: G2, R2

Suggested Citation

Agarwal, Sumit and Ambrose, Brent W. and Yildirim, Yildiray, The Subprime Virus: Theory and Evidence (May 21, 2010). Available at SSRN: https://ssrn.com/abstract=1612948 or http://dx.doi.org/10.2139/ssrn.1612948

Sumit Agarwal (Contact Author)

National University of Singapore ( email )

15 Kent Ridge Drive
Singapore, 117592
Singapore
8118 9025 (Phone)

HOME PAGE: http://www.ushakrisna.com

Brent W. Ambrose

Pennsylvania State University ( email )

University Park, PA 16802-3306
United States
814-867-0066 (Phone)
814-865-6284 (Fax)

Yildiray Yildirim

Zicklin School of Business, Baruch College - The City University of New York ( email )

55 Lexington Ave., Box B13-260
New York, NY 10010
United States

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