Efficient Mortgage Default Option Exercise: Evidence from Loss Severity

Gordon W. Crawford and Eric Rosenblatt
Additional contact information
Gordon W. Crawford: Fannie Mae Financial Analysis Department 3900 Wisconsin Avenue, NW Washington, D.C. 20016-2899, http://www.fanniemae.com/
Eric Rosenblatt: Fannie Mae Financial Analysis Department 3900 Wisconsin Avenue, NW Washington, D.C. 20016-2899, http://www.fanniemae.com/

Journal of Real Estate Research, 1995, vol. 10, issue 5, 543-556

Abstract: This paper extends options-based mortgage default theory to include transaction costs. When transaction costs are considered, the rational borrower will default only when the value of the collateral falls below the mortage value by an amount equal to the net transaction costs. Since, for most borrowers, net transaction costs are positive, standard measures of equity may be significantly negative by the time the rational borrower exercises the default option. This research shows theoretically and empirically the effects of frictions on the individual strike price. The addition of transaction costs to the theory provides several testable implications for equity loss severity. First, the longer the foreclosure process and the period of free rent to the borrower, the lower the severity. Second, severity will be smaller when bankruptcy has been declared. Third, severity is decreasing in the contract decreasing function of the probability of a deficiency judgment. The empirical results, using servicing and foreclosure data from a large northeastern thrift, support the theoretical model.

JEL-codes: L85 (search for similar items in EconPapers)
Date: 1995
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (22)

Downloads: (external link)
http://pages.jh.edu/jrer/papers/pdf/past/vol10n05/v10p543.pdf Full text (application/pdf)

Related works:
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:jre:issued:v:10:n:5:1995:p:543-556

Ordering information: This journal article can be ordered from
Diane Quarles American Real Estate Society Manager of Member Services Clemson University Box 341323 Clemson, SC 29634-1323
http://pages.jh.edu/jrer/about/get.htm

Access Statistics for this article

Journal of Real Estate Research is currently edited by Dr. Ko Wang

More articles in Journal of Real Estate Research from American Real Estate Society American Real Estate Society Clemson University School of Business & Behavioral Science Department of Finance 401 Sirrine Hall Clemson, SC 29634-1323.
Bibliographic data for series maintained by JRER Graduate Assistant/Webmaster ().