Liquidity Contractions and Prepayment Risk on Collateralized Asset Markets

Miguel Iraola and Juan Pablo Torres-Martinez

Working Papers from University of Chile, Department of Economics

Abstract: This paper presents a dynamic general equilibrium model with default and collateral requirements. In contrast with previous literature, our model allows for liquidity contractions and general prepayment specifications. We show that liquidity substantially affects credit and prepayment risks, and that different borrowers may follow differentiated payment strategies: whereas some pay, others prepay or default. The lack of liquidity increases debtors' willingness to continue paying, even thought prepayment cost could be higher than the collateral value. This mechanism rationalizes underwater mortgages. We prove existence of equilibrium, and provide a numerical example illustrating the main determinants of optimal payment strategies.

Pages: 22 pages
Date: 2012-09
New Economics Papers: this item is included in nep-dge and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
http://www.econ.uchile.cl/uploads/publicacion/bec2 ... e2f9c7e3035907a8.pdf (application/pdf)

Related works:
Working Paper: Liquidity Contractions and Prepayment Risk on Collateralized Asset Markets (2012)
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:udc:wpaper:wp364

Access Statistics for this paper

More papers in Working Papers from University of Chile, Department of Economics Contact information at EDIRC.
Bibliographic data for series maintained by Mohit Karnani ().