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Should I default on my mortgage even if I can pay? Experimental evidence

Marina Pavan and Iván Barreda-Tarrazona ()

Journal of Economic Dynamics and Control, 2020, vol. 110, issue C

Abstract: We study strategic default in the laboratory, i.e., in a controlled experiment. Subjects are initially endowed with a house and a mortgage (we use neutral wording in the experiment), and must decide at each period in which their mortgage is alive among three options: making the mortgage payment, selling the house, or walking away from their house and defaulting on their mortgage. At each point in time, we can observe whether defaulters can afford to make the mortgage payment, and thus, directly compute the number of strategic defaulters. Subjects default in the right periods and quite fast learn what they should consume. We find experimental support for the “double trigger” hypothesis: individuals faced with low income and low house prices are more likely to default. We observe that subjects default less than optimal, and this decision is significantly affected by social norm concerns in the context of the experiment. Individuals under-consume in the first periods of life: they are “cautious” when indebted. Both introducing a 50% probability of recourse and a Responsible Homeowner Reward are very effective in preventing default in the lab, especially by individuals receiving a bad shock to income when house prices are low.

Keywords: Strategic mortgage default; Negative equity; Household indebtedness; Housing; Laboratory experiment (search for similar items in EconPapers)
JEL-codes: C91 E70 E21 G41 (search for similar items in EconPapers)
Date: 2020
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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:110:y:2020:i:c:s0165188919301320

DOI: 10.1016/j.jedc.2019.103733

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Journal of Economic Dynamics and Control is currently edited by J. Bullard, C. Chiarella, H. Dawid, C. H. Hommes, P. Klein and C. Otrok

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