Spatial Heterogeneity in Mortgage Terminations by Refinance, Sale and Default

35 Pages Posted: 23 Jul 2003

See all articles by Yongheng Deng

Yongheng Deng

Wisconsin School of Business, University of Wisconsin-Madison

Andrey D. Pavlov

Simon Fraser University (SFU) - Finance Area

Lihong Yang

University of Southern California

Date Written: April 2005

Abstract

This paper investigates the impact of spatially correlated unobservable variables on the refinancing, selling, and default decisions of mortgage borrowers. Virtually the entire mortgage literature acknowledges that borrower specific characteristics, such as culture, education, or access to information, play an important role in the mortgage termination decisions. While we do not observe these variables directly, we note that borrowers of similar background tend to cluster together in neighborhoods. We propose a method to take advantage of this information and reconcile the theoretical option-based models of mortgage terminations with the empirical experience of mortgage refinancing, sale, and default.

Specifically, we estimate a competing risks hazard model with random effect using a three-stage maximum likelihood estimation (3SMLE) approach with space-varying coefficient method (SVC) to modify the covariance structure according to the spatial distribution of the observations. Beyond a significant improvement of the model performance, this yields a number of insightful implications for mortgage termination behavior. For instance, borrowers of the affluent "West Side" of Los Angeles County both refinance and move at a higher rate than predicted by the standard maximum likelihood estimation method. At the same time, borrowers from some lower-valued neighborhoods tend to stay longer than expected with their mortgages and properties. Such findings have direct implications for mortgage pricing and have the potential to ultimately improve the equity and efficiency of the lending markets.

Keywords: duration model, competing risks, space-varying coefficient, martingale residual, mortgage refinance, default, residential mobility

JEL Classification: G21, C31, C41, D12

Suggested Citation

Deng, Yongheng and Pavlov, Andrey D. and Yang, Lihong, Spatial Heterogeneity in Mortgage Terminations by Refinance, Sale and Default (April 2005). Available at SSRN: https://ssrn.com/abstract=419470 or http://dx.doi.org/10.2139/ssrn.419470

Yongheng Deng (Contact Author)

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

Andrey D. Pavlov

Simon Fraser University (SFU) - Finance Area ( email )

Burnaby, British Columbia V5A 1S6
Canada
604 291 5835 (Phone)
604 291 4920 (Fax)

Lihong Yang

University of Southern California ( email )

2250 Alcazar Street
Los Angeles, CA 90089
United States

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