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"Understanding loan modification" with Toshi Onuma

We study homeowners' default behavior and how it responds to income and housing price shocks. The expected debt to income ratio depends not only on expected labor income but also on expected capital gains from the housing market. The model predicts strategic default behavior, which has recently been discussed as an important drive of the foreclosure crises, and generates two testable predictions. 1) Foreclosure hazard rates are positively correlated with homeowners' expected delinquencies, which depend on the history of housing price changes. 2) Subprime loans are more attractive to homebuyers with higher exposure to income shocks and higher probability of default. We suspect that the lack of self-sustainability of the mortgage increases the default risk. We estimate our model using county level foreclosure data. The BLP estimation is used to control for market level unobserved heterogeneity.