The Journal of Real Estate Finance and Economics

, Volume 46, Issue 2, pp 355–378

Residential Mortgage Default: The Roles of House Price Volatility, Euphoria and the Borrower’s Put Option



House price volatility; lender and borrower perception of price trends, loan and property features; and the borrower’s put option are integrated in a model of residential mortgage default. These dimensions of the default problem have, to our knowledge, not previously been considered altogether within the same investigation framework. We rely on a sample of individual mortgage loans for 20 counties in Florida, over the period 2001 through 2008, third quarter, with housing price performance obtained from repeat sales analysis of individual transactions. The results from the analysis strongly confirm the significance of the borrower’s put as an operative factor in default. At the same time, the results provide convincing evidence that the experience in Florida is in part driven by lenders and purchasers exhibiting euphoric behavior such that in markets with higher price appreciation there is a willingness to accept recent prior performance as an indicator of future risk. This connection illustrates a familiar moral hazard in the housing market due to the limited information about future prices.


Residential mortgage default Risk Lending Housing economics Mortgage underwriting 


G21 R11 R20 R21 


  1. Abraham, J. M., & Hendershott, P. H. (1992). Bubbles in metropolitan housing markets, NBER Working Paper No. W4774.Google Scholar
  2. Ambrose, B. W., & Buttimer, R. J. (2000). Embedded options in the mortgage contract. Journal of Real Estate Finance and Economics, 21(2), 95–111.CrossRefGoogle Scholar
  3. Baker, M., & Wurgler, J. (2007). Investor sentiment in the stock market. Journal of Economic Perspectives, 21(2), 129–151.CrossRefGoogle Scholar
  4. Capozza, D. R., & Seguin, P. J. (1996). Expectations, efficiency, and euphoria in the housing market. Regional Science and Urban Economics, 26, 369–386.CrossRefGoogle Scholar
  5. Case, K. E., & Shiller, R. J. (1988). The behavior of home buyers in boom and post-boom markets. New England Economic Review, November-December, pp 29–46.Google Scholar
  6. Demyanyk, Y., & Van Hemert, O. (2008). Understanding the subprime mortgage crisis. Working Paper, Federal Reserve Bank of St. Louis.Google Scholar
  7. Foote, C., Gerardi, K., & Willen, P. (2008). Negative equity and foreclosure: theory and evidence. Journal of Urban Economics, 6(2), 234–245.CrossRefGoogle Scholar
  8. Gerardi, K., Shapiro, A., & Willen, P. (2007). Subprime outcomes: Risky mortgages, homeownership experiences, and foreclosures. Working Paper 07−15, Federal Reserve Bank of Boston.Google Scholar
  9. Goetzmann, W. N., Peng, L., & Yen, J. (2009). The subprime crisis and house price appreciation. Unpublished paper.Google Scholar
  10. Maddala, G. S. (1977). Econometrics. New York: McGraw-Hill Inc.Google Scholar
  11. Ong, S. E., Neo, P. H., & Spieler, A. C. (2006). Price premium and foreclosure risk. Real Estate Economics, 34(2), 211–242.CrossRefGoogle Scholar
  12. Quercia, R. G., Stegman, M. A., & Davis, W. R. (2005). The impact of predatory loan terms on subprime foreclosures: The special case of prepayment penalties and balloon payments, center for community capitalism, Kenan Institute for Private Enterprise. University of North Carolina at Chapel Hill, January 25.Google Scholar
  13. Shiller, R. J. (2005). Irrational exuberance (2nd ed.). Princeton: Princeton University Press.Google Scholar
  14. Smith, B. C. (2009). The Subprime Mortgage Market, a Review and Compilation of Research and Commentary, forthcoming in the Journal of Housing Research. Google Scholar

Copyright information

© Springer Science+Business Media, LLC 2011

Authors and Affiliations

  1. 1.Warrington College of Business Administration Department of Finance Insurance & Real EstateWachovia Fellow University of FloridaGainesvilleUSA
  2. 2.Department of Finance Insurance and Real Estate, Snead School of BusinessVirginia Commonwealth UniversityRichmondUSA

Personalised recommendations