Housing Boom, Mortgage Default and Agency Friction

73 Pages Posted: 17 May 2019

See all articles by Desen Lin

Desen Lin

University of Pennsylvania, Department of Economics

Date Written: December 11, 2018


The paper develops a quantitative framework to understand the dynamics of US house and mortgage markets before and after the Great Recession. I document two facts that jointly seem puzzling in the mortgage credit boom from 2001 to 2007: (1) mortgage risk increased, but (2) the mortgage risk premium decreased. Besides the mortgage risk component in the premium, other time-varying factors must reduce the risk premium in the boom episode. I introduce and calibrate the lending conditions and the mortgage risk as the aggregate shocks to capture time series change in the supply and the demand of mortgage credit. The shocks generate time-varying liquidity and default premiums in the mortgage risk premium respectively. Using a general equilibrium model with borrowers, depositors and intermediaries, I quantify the contribution of aggregate risks to the boom-bust dynamics. I find that the income channel alone cannot generate strong movement in the risk premium under plausible size of shocks, while lending relaxation is essential to explain the mortgage credit boom and the decreasing risk premium. An intermediary is subject to a moral hazard problem whose leverage ratio thus cannot exceed an endogenous cap. The optimal leverage is pro-cyclical and amplifies aggregate shocks through the news effect; bad news of future funding liquidity can hamper today's intermediation and increase the risk premium.

Keywords: housing boom, risk premium, mortgage risk, lending relaxation

JEL Classification: E21, E32, E44, G01

Suggested Citation

Lin, Desen, Housing Boom, Mortgage Default and Agency Friction (December 11, 2018). Available at SSRN: https://ssrn.com/abstract=3367554 or http://dx.doi.org/10.2139/ssrn.3367554

Desen Lin (Contact Author)

University of Pennsylvania, Department of Economics ( email )

PCPSE 535, 133 South 36th Street
Philadelphia, PA 19104
United States

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