Omitted Mobility Characteristics and Property Market Dynamics: Application to Mortgage Termination

Omitted Mobility Characteristics and Property Market Dynamics: Application to Mortgage Termination Property market dynamics depend on changes in long run equilibrium and on impediments to adjustment towards equilibrium. Mortgage termination due to mobility, default and refinancing provides a lens for evaluating property market adjustments. The borrower’s decision to move as an adjustment mechanism in the property market is associated with utility-maximizing decisions to either prepay or default on the mortgage. The optimal choice between these two termination events may depend on unobserved propensities related to change in income, job location, or family size, and substantial inertial forces including search costs, neighborhood change and attachment to an area. We propose a method for modeling variables determining the impact of mobility on mortgage terminations with imperfect household and loan level data. Since omitted variables contribute to moving decisions and therefore to mortgage prepayment and default decisions, utility functions for sale and default are correlated through these unobservable variables; thus, the IIA assumption of the widely used Multinomial Logit Model (MNL) is violated. Under such circumstances, econometric theory suggests that the Nested Logit Model (NMNL) is a better choice, which obviates the limitation of MNL by allowing correlation in unobserved factors across alternatives. Using loan level micro data, we find empirical evidence showing significant correlation between sale and default due to omitted borrower mobility characteristics. Our simulations find that NMNL out performs MNL in out-of-sample prediction. Improved predictions of moves and defaults are applicable to micro and macro analysis of the housing market system. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png The Journal of Real Estate Finance and Economics Springer Journals

Omitted Mobility Characteristics and Property Market Dynamics: Application to Mortgage Termination

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Publisher
Springer US
Copyright
Copyright © 2008 by Springer Science+Business Media, LLC
Subject
Economics; Regional/Spatial Science; Financial Services
ISSN
0895-5638
eISSN
1573-045X
D.O.I.
10.1007/s11146-008-9157-8
Publisher site
See Article on Publisher Site

Abstract

Property market dynamics depend on changes in long run equilibrium and on impediments to adjustment towards equilibrium. Mortgage termination due to mobility, default and refinancing provides a lens for evaluating property market adjustments. The borrower’s decision to move as an adjustment mechanism in the property market is associated with utility-maximizing decisions to either prepay or default on the mortgage. The optimal choice between these two termination events may depend on unobserved propensities related to change in income, job location, or family size, and substantial inertial forces including search costs, neighborhood change and attachment to an area. We propose a method for modeling variables determining the impact of mobility on mortgage terminations with imperfect household and loan level data. Since omitted variables contribute to moving decisions and therefore to mortgage prepayment and default decisions, utility functions for sale and default are correlated through these unobservable variables; thus, the IIA assumption of the widely used Multinomial Logit Model (MNL) is violated. Under such circumstances, econometric theory suggests that the Nested Logit Model (NMNL) is a better choice, which obviates the limitation of MNL by allowing correlation in unobserved factors across alternatives. Using loan level micro data, we find empirical evidence showing significant correlation between sale and default due to omitted borrower mobility characteristics. Our simulations find that NMNL out performs MNL in out-of-sample prediction. Improved predictions of moves and defaults are applicable to micro and macro analysis of the housing market system.

Journal

The Journal of Real Estate Finance and EconomicsSpringer Journals

Published: Oct 7, 2008

References

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