A Model of Mortgage Default

John Campbell and João F. Cocco

No 17516, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: This paper solves a dynamic model of a household's decision to default on its mortgage, taking into account labor income, house price, inflation, and interest rate risk. Mortgage default is triggered by negative home equity, which results from declining house prices in a low inflation environment with large mortgage balances outstanding. Not all households with negative home equity default, however. The level of negative home equity that triggers default depends on the extent to which households are borrowing constrained. High loan-to-value ratios at mortgage origination increase the probability of negative home equity. High loan-to-income ratios also increase the probability of default by tightening borrowing constraints. Comparing mortgage types, adjustable-rate mortgage defaults occur when nominal interest rates increase and are substantially affected by idiosyncratic shocks to labor income. Fixed-rate mortgages default when interest rates and inflation are low, and create a higher probability of a default wave with a large number of defaults. Interest-only mortgages trade off an increased probability of negative home equity against a relaxation of borrowing constraints, but overall have the highest probability of a default wave.

JEL-codes: E21 G21 G33 (search for similar items in EconPapers)
Date: 2011-10
New Economics Papers: this item is included in nep-ban, nep-bec, nep-cba, nep-cis, nep-dge, nep-mac, nep-rmg and nep-ure
Note: AP CF ME
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (37)

Published as JOHN Y. CAMPBELL & JOÃO F. COCCO, 2015. "A Model of Mortgage Default," The Journal of Finance, vol 70(4), pages 1495-1554.

Downloads: (external link)
http://www.nber.org/papers/w17516.pdf (application/pdf)

Related works:
Journal Article: A Model of Mortgage Default (2015)
Working Paper: A Model of Mortgage Default (2015)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:nbr:nberwo:17516

Ordering information: This working paper can be ordered from
http://www.nber.org/papers/w17516

Access Statistics for this paper

More papers in NBER Working Papers from National Bureau of Economic Research, Inc National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.. Contact information at EDIRC.
Bibliographic data for series maintained by ().