Collateral Pledge, Sunk-Cost Fallacy and Mortgage Default

37 Pages Posted: 7 Jun 2014 Last revised: 11 Aug 2014

See all articles by Sumit Agarwal

Sumit Agarwal

National University of Singapore

Richard K. Green

University of Southern California - Lusk Center for Real Estate

Eric Rosenblatt

Federal National Mortgage Association (Fannie Mae) - Research

Vincent Yao

Georgia State University - J. Mack Robinson College of Business

Date Written: August 2014

Abstract

Individuals and firms pledge collateral to mitigate agency costs or contracting frictions in a world with asymmetric information. However, the option value theory suggests that once the mark-to-market asset valuation is below the current debt, the firms and individuals should default on their debt contract irrespective of the initial collateral pledged. In this paper, we estimate default models and find that after controlling for mark-to-market asset valuation, initial collateral remains an important predictor of mortgage default. Specifically, individuals that pledge higher collateral have a lower hazard to default. Our results are consistent with models of sunk cost fallacy.

Keywords: Household Finance, Mortgages, Collateral, Option Value, Financial Crisis, Sunk Cost

JEL Classification: D12, D14, G11, G21

Suggested Citation

Agarwal, Sumit and Green, Richard K. and Rosenblatt, Eric and Yao, Vincent, Collateral Pledge, Sunk-Cost Fallacy and Mortgage Default (August 2014). Available at SSRN: https://ssrn.com/abstract=2446748 or http://dx.doi.org/10.2139/ssrn.2446748

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

Richard K. Green

University of Southern California - Lusk Center for Real Estate ( email )

2250 Alcazar Street
Los Angeles, CA 90089
United States

Eric Rosenblatt

Federal National Mortgage Association (Fannie Mae) - Research ( email )

16517 Keats Terrace
Derwood, MD 20855
United States

Vincent Yao

Georgia State University - J. Mack Robinson College of Business ( email )

35 Broad Street
Atlanta, GA 30303-3083
United States

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