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Stochastic House Appreciation and Optimal Mortgage Lending

Author

Listed:
  • Alexei Tchistyi

    (NYU Stern)

  • Tomasz Piskorski

    (Columbia Business School)

Abstract

Assuming full rationality, we characterize the optimal mortgage contract in a continuous time setting with a risky borrower, costly default, a moral hazard problem between the borrower and the lender, and a stochastic house appreciation. We show that many features of subprime lending observed in practice are consistent with economic e¢ ciency and rationality of both borrowers and lenders. In particular, preferential treatment of subprime borrowers is optimal during the housing boom, while default clustering among subprime borrowers is optimal during the housing slump. We also find that stochastic house appreciation makes it profitable to give loans to subprime borrowers who otherwise would be shut out of the housing market, which generates substantial ex-ante utility gains for these borrowers.

Suggested Citation

  • Alexei Tchistyi & Tomasz Piskorski, 2008. "Stochastic House Appreciation and Optimal Mortgage Lending," 2008 Meeting Papers 938, Society for Economic Dynamics.
    • Handle: RePEc:red:sed008:938
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    References listed on IDEAS

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    Cited by:

    1. Igor Makarov & Guillaume Plantin, 2013. "Equilibrium Subprime Lending," Journal of Finance, American Finance Association, vol. 68(3), pages 849-879, June.
    2. Andrew F. Haughwout & Christopher J. Mayer & Joseph Tracy, 2009. "Subprime mortgage pricing: the impact of race, ethnicity, and gender on the cost of borrowing," Staff Reports 368, Federal Reserve Bank of New York.
    3. Piskorski, Tomasz & Seru, Amit & Vig, Vikrant, 2010. "Securitization and distressed loan renegotiation: Evidence from the subprime mortgage crisis," Journal of Financial Economics, Elsevier, vol. 97(3), pages 369-397, September.
    4. James A. Kahn, 2008. "What drives housing prices?," Staff Reports 345, Federal Reserve Bank of New York.

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