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Title: Credit risks and default behavior of mortgagors
Authors: LIU BO
Keywords: Mortgage, Default, Hazard, Self-Selection, Market Structure, Option, Crisis
Issue Date: 23-May-2011
Citation: LIU BO (2011-05-23). Credit risks and default behavior of mortgagors. ScholarBank@NUS Repository.
Abstract: This study adds to the understanding of residential mortgage default in three aspects: (i) borrowers? self-selection, (ii) ?non-strategic? mortgage default, and (iii) banking market structure effect. Firstly, borrowers? contract choice is modeled under life-time utility maximization in the rational consumption of housing and non-housing services. The simulation shows that heterogeneous borrowers have different preference for mortgage contracts (mortgage type and/or LTV), given the mortgage rate and borrowers? observable and unobservable characteristics (such as income and credit score) (ceteris paribus). Heckman?s two-step empirical tests are conducted to study the unobservable risk factor effect (that reflected in borrowers? mortgage choice) on mortgage ex-post default risk. Comparative self-selection and self-selection into fixed rate mortgages (FRMs) are found to reduce mortgage default risks. In addition, borrowers, who self-select into adjustable rate mortgages (ARMs), have higher ex-post default probability relative to other borrowers. The self-selection effects are reinforced by high credit scores (FICO) of borrowers. The second part is to explain non-ruthless and suboptimal default behavior of borrowers. A rational default model by borrowers? life-time utilities extending beyond the negative equity of mortgage is proposed and simulated. Split population model, which allows the separation of ?probability of default? and ?time-to-default? and the existence of ?non-defaulters?, and have better fitting than normal hazard regression statistically, is used to empirically test the proposed rational default model. Although high-risk borrowers (e.g., mortgagors with extremely high LTV, No FICO, and Low FICO) have high probability of becoming defaulters, they are more ?non-ruthless? in exercising default options because of their limited credit accessibility. Mortgage characteristics are less important in borrowers? decision on suboptimal default supporting that unexpected ?trigger event? is critical for suboptimal default behaviors. Thirdly, the question on ?how do the banking market structures (contestability and concentration) affect non-agency residential mortgage supply and its performance?? is empirically studied. The results suggest that contestability in the banking market reduces credit supply and concentration in the banking market increases total credit supply during 2000s, when the market faces with the downturn in demand and in the existence of non-bank substitution suppliers. Furthermore, competitive contestability factor increases total credit supply, and reduces ex-post default risks compared with other market structure effects (e.g., monopoly contestable, monopoly inefficiency, and cut-throat competitive market). The results imply that collecting individual information (e.g., income, consumption preference, payment habits, and submarket status) is important in evaluating default risks of borrowers.
Appears in Collections:Ph.D Theses (Open)

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