An Equilibrium Model of Housing and Mortgage Markets with State-Contingent Lending Contracts

60 Pages Posted: 25 Jan 2017 Last revised: 6 Nov 2017

See all articles by Tomasz Piskorski

Tomasz Piskorski

Columbia Business School - Finance and Economics

Alexei Tchistyi

University of Illinois at Urbana-Champaign - Department of Finance

Multiple version iconThere are 2 versions of this paper

Date Written: September 2017

Abstract

We develop a tractable general equilibrium framework of housing and mortgage markets with aggregate and idiosyncratic risks, costly liquidity and strategic defaults, empirically relevant informational asymmetries, and endogenous mortgage design. We show that adverse selection plays an important role in shaping the form of an equilibrium contract. If borrowers' homeownership values are known, the equilibrium state-contingent contract depends on both aggregate wages and house prices. However, when lenders cannot observe borrowers' homeownership values, the equilibrium contract only depends on house prices and takes the form of a home equity insurance mortgage (HEIM) that eliminates the strategic default option and insures the borrower's equity position. Interestingly, we show that widespread adoption of such loans has ambiguous effects on the homeownership rate and household welfare. In economies in which recessions are expected to be severe, the HEIM equilibrium Pareto dominates the equilibrium with fixed-rate mortgages. However, if economic downturns are not severe, HEIMs can lower the homeownership rate and make some marginal home buyers worse-off. We also note that adjustable-rate mortgages (ARMs) may share some benefits with HEIMs. Finally, we find that unrestricted competition in contract design among lenders may lead to a non-existence of equilibrium. This suggests that government-sponsored enterprises may stabilize mortgage markets by subsidizing certain lending contracts.

Keywords: State-contingent lending contracts, mortgage design, home equity insurance, asymmetric information, housing market, general equilibrium

JEL Classification: G21, G28, G01, D1, D5, E3

Suggested Citation

Piskorski, Tomasz and Tchistyi, Alexei, An Equilibrium Model of Housing and Mortgage Markets with State-Contingent Lending Contracts (September 2017). Columbia Business School Research Paper No. 17-18. Available at SSRN: https://ssrn.com/abstract=2904676 or http://dx.doi.org/10.2139/ssrn.2904676

Tomasz Piskorski (Contact Author)

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States

Alexei Tchistyi

University of Illinois at Urbana-Champaign - Department of Finance ( email )

1206 South Sixth Street
Champaign, IL 61820
United States

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