Stochastic House Appreciation and Optimal Mortgage Lending
Coauthor(s): Alexei Tchistyi.
We characterize the optimal mortgage contract in a continuous time setting with stochastic growth in house price and income, costly foreclosure, and a risky borrower who requires incentives to repay his debt. We show that many features of subprime loans can be consistent with properties of the optimal contract and that, when house prices decline, mortgage modification can create value for borrowers and lenders. Our model provides a number of empirical predictions that relate the features of mortgage contracts originated in a housing boom and the extent of their modification
in a slump to location and borrowers' characteristics.
Source: Review of Financial Studies
Piskorski, Tomasz, and Alexei Tchistyi. "Stochastic House Appreciation and Optimal Mortgage Lending." Review of Financial Studies 24, no. 5 (May 2011): 1407-1446.