Mortgage Default in Local Markets

Drawing from a large mortgage loan database and an extensive panel data set on metropolitan areas, this study refines the contingent claims model of default. Recent research has treated default as optimal exercise of a put option and has emphasized loan to value ratios, loan age and interest rate measures. Transactions costs and trigger events like unemployment and divorce should also play a role in optimal default; but the importance of these costs have become contentious. The results confirm the statistical significance of each of these variables; however, the economic importance of transactions costs and trigger events is definitely secondary to the frictionless options model variables. By analyzing the data at both the metro area level and the regional level, we show that one reason other studies have found conflicting results is low statistical power arising from highly aggregated data and/or short sample periods