Abstract
This study releases assumptions on previous borrowers’ mortgage choice under information asymmetric: exogenously known default risk and lenders’ zero profit. Through maximizing borrowers’ life-time utilities in housing and non-housing consumption, simulation results show that borrowers’ observable choices basket of mortgage type, preferred LTV, and house size, could reflects unobservable and unverifiable risk factors like real income, wealth, credit worthiness, and housing consumption preference. Further empirical tests, based on individual mortgages from non-agency residential mortgage backed securities, show that some mortgage selection baskets could systematically reflect t unobservable risk factors, which should not be ignored in analyzing mortgagors’ ex-post default. The results also suggest the requirements on understanding borrowers’ incentives and the necessity to gain more borrowers’ information on mortgage’s risk management. This paper might provide broader understanding from individual borrowers’ behaviors at micro-level to explanation on massive defaults in subprime crisis of potential real income story at macro-level.
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