Contagion Effects in Strategic Mortgage Defaults

Abstract

Using a large sample of U.S. mortgages, we document contagion effects in strategic mortgage defaults. These result from borrowers choosing to exercise their in the money default option. Our findings suggest this choice is influenced by the delinquency rate in surrounding zip codes after controlling for determinants of mortgage default. The fact that the local area delinquency rate is an important factor for strategic defaulters but not for defaults that are the result of inability to pay supports the contagion hypothesis. Our estimates suggest a 1% increase in the delinquency rate increases the probability of a strategic default up to 16.5%.

Keywords: Foreclosure contagion, strategic defaults, mortagages, underwater homes

JEL Classification: G21, D83