Default Option Exercise over the Financial Crisis and beyond*

Predatory lending and the subprime crisis

Xudong An, Yongheng Deng and Stuart Gabriel

Review of Finance, 2021, vol. 25, issue 1, 153-187

Abstract: We document changes in borrowers’ sensitivity to negative equity and show heightened borrower default propensity as a fundamental driver of crisis period mortgage defaults. Estimates of a time-varying coefficient competing risk hazard model reveal a marked run-up in the default option beta from 0.2 during 2003–06 to about 1.5 during 2012–13. Simulation of 2006 vintage loan performance shows that the marked upturn in the default option beta resulted in a doubling of mortgage default incidence. Panel data analysis indicates that much of the variation in default option exercise is associated with the local business cycle and consumer distress. Results also indicate elevated default propensities in sand states and among borrowers seeking a crisis-period Home Affordable Modification Program loan modification.

Keywords: Mortgage default; Option exercise; Default option beta; Time-varying coefficient hazard model (search for similar items in EconPapers)
JEL-codes: C13 G12 G18 G21 (search for similar items in EconPapers)
Date: 2021
References: Add references at CitEc
Citations: View citations in EconPapers (2)

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