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Bias in estimates of discrimination and default in mortgage lending: The effects of simultaneity and self-selection

Abstract

The common practices of estimating single-equation models of mortgage rejection to test for discrimination in mortgage markets or single-equation ex ante mortgage default equations to validate underwriting criteria produce biased and inconsistent parameter estimates. This is due to problems of simultaneous equations bias which arise because, in a world of imperfect information, mortgage terms are not exogenous to the rejection or default decision. In addition, mortgage default estimates are also subject to selection bias. Monte Carlo experiments are used to study the nature and extent of likely bias in single-equation estimation results. We find that rejection equation estimates indicate discrimination when none exists and that estimated coefficients of mortgage terms, such as the loan-to-value ratio, are also subject to significant bias in both rejection and default equations.

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Yezer, A.M.J., Phillips, R.F. & Trost, R.P. Bias in estimates of discrimination and default in mortgage lending: The effects of simultaneity and self-selection. J Real Estate Finan Econ 9, 197–215 (1994). https://doi.org/10.1007/BF01099273

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Key words

  • Single equation models
  • mortgage markets
  • Monte Carlo experiments
  • rejection equation estimates
  • default equation estimates