Liquidity Constraints, Home Equity and Residential Mortgage Losses

Abstract

This paper analyses how borrower liquidity constraints and home equity relate to the realized loss given default (LGD) using the quarterly U.S. residential mortgage loan-level data observed from Q2 2005 to Q1 2015. We define defaulted loans with zero-LGD as cure loans and those with non-zero LGD as non-cure loans. We find robust evidence that the borrower liquidity constraints and positive equity are explaining cure, while negative equity explains non-zero loss. However, a relationship between borrower liquidity constraints and the non-zero LGD is not economically meaningful. Our findings support to separate cure and non-cure loans in mortgage loss risk models.

Keywords: Cure, Loss Given Default, Liquidity Constraints, Home Equity, Mortgage, Selection

JEL Classification: G21, G28, C19