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Equity Dilution: An Alternative Perspective on Mortgage Default
Author(s) -
LaCourLittle Michael
Publication year - 2004
Publication title -
real estate economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.064
H-Index - 61
eISSN - 1540-6229
pISSN - 1080-8620
DOI - 10.1111/j.1080-8620.2004.00095.x
Subject(s) - loan to value ratio , equity (law) , economics , unobservable , lien , mortgage underwriting , leverage (statistics) , put option , probability of default , financial economics , actuarial science , loan , debt , debt to equity ratio , default , mortgage insurance , monetary economics , econometrics , finance , credit risk , nonprobability sampling , population , demography , machine learning , casualty insurance , sociology , political science , computer science , insurance policy , law
Empirical research on mortgage default in the single‐family market has focused on the value of the borrower's put option using house price indices to estimate contemporaneous loan‐to‐value ratio or the probability of negative equity. But since the borrower possesses the option to increase leverage by taking on additional debt secured by junior liens subsequent to loan origination (a phenomenon termed here equity dilution ), even a perfect house price adjustment cannot be expected to accurately measure changes in borrower equity over time. Since junior liens are generally unobservable to senior debt holders, proxies are required in empirical applications. This paper employs an independent estimate of junior lien probability developed from the 1998 Survey of Consumer Finances combined with loan level mortgage performance data to examine the role junior liens play in increasing default risk.