Default Option Exercise Over the Financial Crisis and Beyond

59 Pages Posted: 15 Apr 2016

See all articles by Xudong An

Xudong An

Federal Reserve Banks - Federal Reserve Bank of Philadelphia

Yongheng Deng

Wisconsin School of Business, University of Wisconsin-Madison

Stuart A. Gabriel

University of California, Los Angeles - Anderson School of Management

Date Written: April 6, 2016

Abstract

We document increased ruthlessness of mortgage default option exercise over the financial crisis and beyond. For a given level of negative equity, borrower propensity to default rose markedly over the 2007-2012 period and among hard-hit metropolitan areas. We show that elevated default option exercise was more salient to crisis-period defaults than were adverse shocks to home equity. Analysis of time-series and panel data indicates that proxies for the local business cycle, consumer sentiment, and federal foreclosure mitigation programs explain much of the rise in the negative equity beta. Difference-in-difference tests further corroborate unintended consequences of the Home Affordable Modification Program (HAMP) on borrower default option exercise.

Keywords: Mortgage default; option exercise; negative equity beta; HAMP

JEL Classification: G21; G12; C13; G18

Suggested Citation

An, Xudong and Deng, Yongheng and Gabriel, Stuart A., Default Option Exercise Over the Financial Crisis and Beyond (April 6, 2016). Available at SSRN: https://ssrn.com/abstract=2764026 or http://dx.doi.org/10.2139/ssrn.2764026

Xudong An

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

Ten Independence Mall
Philadelphia, PA 19106-1574
United States

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

Stuart A. Gabriel (Contact Author)

University of California, Los Angeles - Anderson School of Management ( email )

110 Westwood Plaza
Los Angeles, CA 90095-1481
United States
310-825-2922 (Phone)
310-206-5455 (Fax)

HOME PAGE: http://www.anderson.ucla.edu

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