Premium
Unobservable Risks in Mortgage Contract Choice
Author(s) -
Liu Bo,
Sing Tien Foo
Publication year - 2013
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/reec.12014
Subject(s) - unobservable , mortgage underwriting , loan to value ratio , mortgage insurance , utility maximization , loan , economics , shared appreciation mortgage , mortgage loan , actuarial science , ex ante , econometrics , finance , macroeconomics , mathematical economics , casualty insurance , insurance policy
This study proposes a lifetime utility maximization model where borrowers choose optimal mortgage bundles including mortgage type, loan‐to‐value and loan size to maximize their allocation of limited budgets between housing and nonhousing consumptions. The model predicts that the mortgage bundle choices by borrowers of different income and risk attributes explain significant variations in the ex post default risks of the borrowers. The empirical tests using sampled mortgages pooled in nonagency residential mortgage backed securities support the hypothesis that the optimal choice of mortgage bundles reveals hidden risk factors of borrowers, which, if ignored, could lead to misjudgment of ex post default of borrowers.