An Empirical Model of Subprime Mortgage Default from 2000 to 2007 ∗

We quantify the relative importance of various drivers behind subprime borrowers’decision to default. In our econometric model, we allow borrowers to default either because doing so increases their lifetime wealth or because of short-term credit constraints, taking into account that either factor by itself is suffi cient to induce default. Our model also incorporates various proxies for borrowers’beliefs about future housing prices without imposing beliefs that are necessarily rational. According to our results, the two key drivers behind the recent increase in defaults are the nationwide decrease in home prices and the increase in the number of borrowers with poor credit and high payment-to-income ratios. We use our model to evaluate alternative policies aimed at reducing the rate of default.