Omitted Mobility Characteristics and Property Market Dynamics: Application to Mortgage Termination

Posted: 26 May 2010

See all articles by Xudong An

Xudong An

Federal Reserve Banks - Federal Reserve Bank of Philadelphia

John M. Clapp

University of Connecticut - Department of Finance

Yongheng Deng

Wisconsin School of Business, University of Wisconsin-Madison

Date Written: May 25, 2010

Abstract

Property market dynamics depend on changes in long run equilibrium and on impediments to adjustment towards equilibrium. Mortgage termination due to mobility, default and refinancing provides a lens for evaluating property market adjustments. The borrower's decision to move as an adjustment mechanism in the property market is associated with utility-maximizing decisions to either prepay or default on the mortgage.

The optimal choice between these two termination events may depend on unobserved propensities related to change in income, job location, or family size, and substantial inertial forces including search costs, neighborhood change and attachment to an area. We propose a method for modeling variables determining the impact of motility on mortgage terminations with imperfect household and loan level data.

Since omitted variables contribute to moving decisions and therefore to mortgage prepayment and default decisions, utility functions for sale and default are correlated through these unobservable variables; thus, the IIA assumption of the widely used Multinomial Logit Model (MNL) is violated. Under such circumstances, econometric theory suggests that the Nested Logit Model (NMNL) is a better choice, which obviates the limitation of MNL by allowing correlation in unobserved factors across alternatives.

Using loan level micro data, we find empirical evidence showing significant correlation between sale and default due to omitted borrower mobility characteristics. Our simulations find that NMNL out performs MNL in out-of-sample prediction. Improved predictions of moves and defaults are applicable to micro and macro analysis of the housing market system.

Keywords: Housing Market, Mobility, Mortgage Termination, Multinomial Logit Model

Suggested Citation

An, Xudong and Clapp, John M. and Deng, Yongheng, Omitted Mobility Characteristics and Property Market Dynamics: Application to Mortgage Termination (May 25, 2010). Journal of Real Estate Finance and Economics, Vol. 41, No. 3, 2010. Available at SSRN: https://ssrn.com/abstract=1615565

Xudong An (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Philadelphia ( email )

Ten Independence Mall
Philadelphia, PA 19106-1574
United States

John M. Clapp

University of Connecticut - Department of Finance ( email )

School of Business
2100 Hillside Road
Storrs, CT 06269
United States
860-486-5057 (Phone)
860-486-0349 (Fax)

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

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