Macroeconomic Adverse Selection and Model Instability in Mortgage Credit Risk
23 Pages Posted: 13 Feb 2017
Date Written: February 1, 2017
This paper explains how unobserved borrower risk factors and changing economic expectations can interact to create vintage effects and parameter instability in mortgage credit risk models. We develop a model of mortgage choice and default behavior that demonstrates how this could have led to underestimation of the risk of high LTV mortgages before the crisis. This analysis offers some guidance for reducing model risk.
Keywords: Credit risk, Credit cycle, Mortgages, Financial crisis
JEL Classification: G20, G21
Suggested Citation: Suggested Citation