Thursday, June 3, 2010

Subprime Mortgage Default

By James B. Kau, Donald C. Keenan, Constantine Lyubimov and V. Carlos Slawson Jr.

Abstract: Using data on privately-securitized subprime ARMs (adjustable rate mortgages) originated between 1997 and 2008 and observed between 2000 and 2008, and so covering the start of the subprime crisis, this paper constructs a reduced-form credit risk model of default, and then uses contractual properties of the loans to infer the market’s price of default risk at various times of origination.

Treating the hazard of default as a process rather than a single realization for each period of origination permits the probability of default to be calculated without knowledge of the still unfolding hazard realization, allowing one to adopt the same position as lenders, who also cannot foretell the future. It is empirically determined that a change in the inherent nature of borrowers caused some deterioration in their default behavior, a change which we can first detect by late 2004, but of which, evidence indicates, the secondary mortgage market became aware at about the same time. The large rise in defaults in 2007 cannot, therefore, be attributed to any surprise other than the unexpectedly large fall in housing prices.

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1 comment:

  1. The subprime mortgage default issue continues to haunt many American homeowners nowadays. Nevertheless, there's always hope to recover. Here in Canada, mortgage companies are offering low rates. And yet, people are still prudent to rely on their hired independent mortgage adviser from a trusted Fort Mcmurray mortgage company. Besides, I remember a mortgage broker in Calgary telling my neighbor that it is the perfect time to buy homes when companies are offering low mortgage rates. Before making a decision though, homebuyers need to do careful planning and extensive research first. Thanks for sharing this interesting post!


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