Unemloyment and Unobserved Credit Risk in the FHA Single Family Mortgage Insurance Fund

Joseph Gyourko and Joseph Tracy

No 18880, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Empirical models of mortgage default typically find that the influence of unemployment is negligible compared to other well known risk factors such as high borrower leverage or low borrower FICO scores. This is at odds with theory, which assigns a critical role to unemployment status in the decision to stop payment on a mortgage. We help reconcile this divergence by employing a novel empirical strategy involving simulated unemployment histories to measure the severity of attenuation bias in loan-level estimations of default risk due to a borrower becoming unemployed. Attenuation bias results because individual data on unemployment status is unobserved, requiring that a market-wide unemployment rate be used as a proxy. Attenuation is extreme, with our results suggesting that the use of an aggregate unemployment rate in lieu of actual borrower unemployment status results in default risk from a borrower becoming unemployed being underestimated by a factor of 100 or more. Correcting for this indicates unemployment is more powerful than other well-known factors such as extremely high leverage or extremely low FICO scores in predicting individual borrower default. Our simulated data indicate that adding the unemployment rate as a proxy for the missing borrower-specific unemployment indicator does not improve the accuracy of the estimated model over the specification without the proxy variable included.

JEL-codes: G17 R48 (search for similar items in EconPapers)
Date: 2013-03
Note: PE
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Citations: View citations in EconPapers (10)

Published as Journal of Urban Economics Volume 80, March 2014, Pages 87–96 Cover image Reconciling theory and empirics on the role of unemployment in mortgage default Joseph Gyourkoa, Joseph Tracyb, , ,

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