Collateral pledge, sunk-cost fallacy and mortgage default

Sumit Agarwal, Richard Green (), Eric Rosenblatt and Vincent Yao

Journal of Financial Intermediation, 2015, vol. 24, issue 4, 636-652

Abstract: Individuals and firms pledge collateral to mitigate agency costs or contracting frictions in a world with asymmetric information. However, the option value theory suggests that once the mark-to-market asset valuation is below the current debt, the firms and individuals should default on their debt contract irrespective of the initial collateral pledged. In this paper, we estimate default models and find that after controlling for mark-to-market asset valuation, initial collateral remains an important predictor of mortgage default. Specifically, individuals that pledge higher collateral have a lower hazard to default. Our results are consistent with models of sunk cost fallacy.

Keywords: Household finance; Mortgages; Collateral; Option value; Financial crisis; Sunk cost (search for similar items in EconPapers)
Date: 2015
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Citations: View citations in EconPapers (13)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinin:v:24:y:2015:i:4:p:636-652

DOI: 10.1016/j.jfi.2014.10.001

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