Literature Review on Mortgage Default

writings Review on Mortgage slacknessLiterature reviewThe evolution of mortgage disrespect studies is characterized by Quercia and Stegman (1992) into three types of studies. The earlier work dating back to the 1970s focuses from a lenders perspective on simple correlations and regression models capturing important drawer characteristics that buttocks forecast banking companyruptcy. Home justice, income variability, deprivation of employment, death, and divorce ar found to be the most important predictors of oversight risk (Von Furstenberg, 1969 Herzog and Early, 1970 caravandell, 1978).The second generation of c arlessness research, rooted in consumer behaviour theory, models the behavior of nominateholds, who rationally decide to neglect, in a to a greater extent morphologic way. Papers by Jackson and Kasserman (1980), Campbell and Dietrich (1983), and Foster and Van Order (1984) explicitly formulate last-place-equity maximization models of default. Such ruthless default models predict conterminous default if a propertys pass judgment drops a small margin to a note place the level of the mortgage. These models emphasize the pecuniary aspects of the mortgage default decision, ignoring borrowers characteristics.Towards the start of the 1990s, several(prenominal) models began examining transaction costs and crisis events that may delay, expedite, or eliminate the need to default. Quigley and Van Order (1992) find that transaction and reputation costs make the default option on mortgages less ruthless than in other frictionless financial markets. piece of music transaction costs by themselves do non explain observed behavior, reputation costs in particular atomic number 18 consistent with observed default behavior. These second-generation studies constitute the basis for the current defer of the theory. The examination of the default decision as an option and the central division of net equity constitute the dominant view in studies o f default. Conceptually, the prefatorial theory postulated by second-generation studies has non been revised since.The recent financial crisis has emotional a revival of the academic interest in mortgage default, and the pedigree of a third generation of research models. Specifically, there have been attempts to blend mortgage default into more general balance models of consumer behavior. Campbell and Cocco (2014) model mortgage foreclosures structurally and find negative equity, borrowing constraints, high debt-to-income ratios and income growth as important determinants of foreclosure. Goodhart et al. (2011) and Foote et al. (2008) use a 2-period model to show that households consume to default and lose their homes to foreclosure, if the net implicit rents from owning plus the expected net equity position over their tenure horizon is negative. They find that expected house price appreciation, and the size of the mortgage payment are the main factors in determining default. Corradin (2012) builds a life-cycle continuous-time model of household leverage and default in which the agents optimally choose the down-payment, abstracting from inflation and interest rate risk. Garriga and Schlagenhauf (2009) also realise an equilibrium model of long-term mortgage choice and default to ensure how leverage affects the default decision.Forlati and Lambertini (2011), the closest paper to this thesis, builds an countless-horizon DSGE model with hold, risky mortgages and endogenic default. They introduce idiosyncratic risk in housing dropment and the calamity for loans to be defaulted on, which results in an endogenous borrowing constraint exactly as the one for firms in Bernanke, Gertler, and Gilchrist (1999). Their model does not feature any penalties for the households that choose to default. This assumption is unrealistic, as in the United States as well as in other countries, defaulters incur reputation and credit score penalties which affect their possib ility to borrow in the future, in attachition to collateral losses. Hence, introducing non-pecuniary default penalties is useful when thinking about an equilibrium with default. The Forlati and Lambertini (2011) model also does not include a financial sector, therefore the financial accelerator implement is absent, in particular the banking side. There is no role for negative feedback loops direct through the banking sector as rising bad loan books and bank insolvencies, amplified by a liquidity crisis, can lead to a sapiently credit contraction. This thesis builds a model incorporating approximately of these missing links.The literature review indicates a continued interest in mortgage default. While most empirical studies are well-advanced in their discoveries of the determinants of default, the theoretical literature is follow behind developing models able to capture these determinants. I attempt to twain the gap in the midst of the empirical determinants of default and t he theory, by constructing a high-energy optimization model of borrower choice with housing market frictions and endogenous mortgage default, that will feature default centered around negative net equity, reputation penalties, and house valuation shocks. Refining the current DSGE models with the introduction of financial and micro-founded consumer behavior frictions is essential for the study of business cycles and financial stability.Theoretical shapeThis thesis builds a DSGE model drawing on a chip of contributions in the literature on credit markets, housing markets, and debt default. The starting invest is a model with financial frictions on the demand-side for credit (i.e. Kiyotaki and Moore, 1997 Iacoviello and Neri, 2010), to which I add a housing sector, a financial sector and endogenous debt default. The thought process of default comes from the asset pricing literature, which allows for the existence of default as an equilibrium phenomenon (Dubey et al., 2005 Geanakop los and Zame, 2013). A stylized representation of the model is depicted in attend reffig8. The economy operates in discrete time over an infinite horizon and combines five elements 1) two types of households, namely textitsavers and textitborrowers, who consume manufactured goods, stack up housing, and work 2) a financial sector collecting deposits and playing collateralized mortgages 3) a capacious set of real ( expenditure habits, adjustment costs) and nominal (price and wage) rigidities 4) financing frictions in the housing and financial sector and 5) a rich set of shocks, essential in taking the model to the data.The economy is populated by patient (savers) and agitated (borrowers) households. Patient households consume, cumulate housing stock, save, and work. They own the productive capital of the economy, and tag on capital funds to firms on the one hand, and deposits to banks on the other. Impatient households consume, accumulate housing stock, borrow from banks, and w ork. Both patient and impatient households supply exertion services through labor unions, which set their wages subject to a Calvo scheme. On the supply side, the non-housing sector combines labor and capital to produce use and business capital for both sectors. The construction sector produces new homes feature labor and land with business capital.The two groups of households have different subtraction factors. Discount factor heterogeneity between households induces heterogeneity in the bare(a) utility of saving across households. All else equal, borrowers have a lower $beta*$ and a higher marginal utility of immediate consumption relative to savers, inducing a desire to trade inter-temporally. Borrowers obtain collateralized mortgages from banks, succession savers have a high discount factor $beta$ and invest their resources into bank deposits. The handiness of loans to borrowers is subject to a borrowing constraint tie in to the market value of their housing stock and th e ability of the lending banks to extend credit. Borrowers can experience negative housing value shocks that are exclusively observed by the households themselves. When the value of their house falls below the value of their loan repayment, they choose to default on part of their mortgage. Default on secured debt is modeled through the partial loss of collateral and a non-pecuniary default penalty that enters the utility function of the households directly. In case of default, borrowers lose some of their housing stock which is repossessed by the bank, suffer a non-pecuniary default penalty, and re-enter the housing market in the next period as buyers again. Default is endogenously determined and, consistent with the literature on second-generation default models, triggered by shocks that are large enough to cause leveraged households to owe on their house more than the house is worth.Borrowers and savers are unable to directly write financial contracts. They do so through financia l intermediaries. The financial sector is simply market-based banks borrow from savers in order to give loans to borrowers. In this way, I layer two sets of financial frictions that interact in equilibrium first, banks are constrained in how much they can borrow from ultimate savers, and second ultimate borrowers are constrained in how much they can borrow from the banks. Monetary indemnity is conducted by a central bank which faces a trade-off between output gap and inflation stabilization.The model provides a framework to show the impact of house price fluctuations, monetary policy, demand shocks, and credit availability on the economy and the ways in which financial regulation can dampen boom and bust cycles in the housing market.