This paper studies optimal mortgage design in a continuous time setting with volatile and privately observable income, costly foreclosure, and a stochastic market interest rate. We show that the features of the optimal mortgage are consistent with an option adjustable-rate mortgage (option ARM)....

This paper studies optimal mortgage design in a continuous time setting with volatile and privately observable income, costly foreclosure, and a stochastic market interest rate. We show that the features of the optimal mortgage are consistent with an option adjustable-rate mortgage (option ARM)....

This paper explores the practice of mortgage refinancing in a dynamic competitive lending model with risky borrowers and costly default. We show that prepayment penalties improve welfare by ensuring longer-term lending contracts, which prevents the mortgage pools from becoming disproportionately...

We develop a tractable general equilibrium framework of housing and mortgage markets with aggregate and idiosyncratic risks, costly liquidity and strategic defaults, empirically relevant informational asymmetries, and endogenous mortgage design. We show that adverse selection plays an important...

This paper explores the practice of mortgage refinancing in a dynamic competitive lending model with risky borrowers and costly default. We show that the prepayment penalties are welfare improving, and that they are more beneficial to borrowers with higher risk of default. The empirical evidence...

the market interest rate is low. Thus, our analysis provides theoretical evidence that these alternative mortgages, which have recently generated great controversy, can benefit both lenders and borrowers.

This paper provides a theoretical analysis of the efficiency of prepayment penalties in a dynamic competitive lending model with risky borrowers and costly default. When considering improvements in the borrower's creditworthiness as one of the reasons for refinancing mortgages, we show that...