Does it Pay Not to Pay? An Empirical Model of Subprime Mortgage Default from 2000 to 2007

To understand the relative importance of various incentives for subprime borrowers to default on their mortgages, we build an econometric model that nests various potential drivers of borrower behavior. We allow borrowers to default on their mortgages either because doing so increases their lifetime utility or because of the borrowers’ inability to pay, treating the decision as the outcome of a bivariate probit speci…cation with partial observability. We estimate our model using detailed loan-level data from LoanPerformance and the Case-Shiller home price index, and …nd that liquidity constraints are as empirically important an explanation as declining house prices for the increase in subprime defaults over recent years. Expectations about future home price movements and changes in the interest rate environment also contributed to the recent rise in defaults, but their actual e¤ects are not large. We thank Narayana Kocherlakota, Andreas Lehnert, Monika Piazzesi, Tom Sargent, and Dick Todd for helpful conversations. Bajari would like to thank the National Science Foundation for generous research support. The views expressed are those of the authors and do not necessarily re‡ect the o¢ cial positions of the Federal Reserve System. Correspondence: [email protected]; [email protected]; [email protected].