Study On Micro-Structure Of Home Mortgage Market

Banks are the most important part in the financial system in China, and of theirassets, mortgages, especially residential mortgages are the most important. The USSubprime Crisis told us that if there is some trouble in banks’ mortgages, the wholefinancial system as well as the whole economy may suffer. Therefore, we make thisstudy on home mortgages.Two problems have being concerned in past research on mortgages. One is theforeclosure rate and its possible reasons to change. These researches may use simplemodels going with empirical research carrying great amount of data on micro activity.The other is the valuation of mortgages if banks are willing to sell them to others.These researches usually deal with mortgages like options, using newly developedfinancial pricing theory to calculate the mortgage value. Both kinds are important.However, there is one assumption in both of them that applicants are homogeneous.There might be heterogeneity in the empirical research on foreclosure rate, but thisheterogeneity is caused by the same distribution of some mortgage applicants’ quality.Moreover, if we consider heterogeneity in mortgage pricing, the solution might bealmost impossible, hard work on which is worse than a better estimation of thevariables on homogeneity model.Importing heterogeneity, three aspects are studied in this article. First, if thereare some factors influencing the foreclosure rate, how the influence is affected byheterogeneity. In other words, if there is only one kind of individuals, a factorchanges and something happens, it behaves as if there is only one man. But if thereare various kinds of individuals, a factor changes and different things happen fordifferent people. The inner structure of the individual might change. The foreclosurerate we study is a piece of it. Second, if the mortgage applicants are different, theydeserve different mortgages and banks may provide them with different ones. How dothese mortgages value? We call this the mortgage-menu problem. Third, if theapplicants are different, they may apply for different mortgages. How do they select? What does this mean to the financial system? The answer for the first question givesus the relationship between our research and the banking management. The answerfor the second tells us how banks make decisions in different market structures. Theanswer for the third shows us that how do individuals’ self-decisions split the market.By answering these questions, a research path to the micro structure of the mortgagemarket is found.Basically we assume that people buy house for investment, not for consumption.And then we changed some characteristics of the Frictionless Option Model. We use a2-period economy instead of the long time assumption of traditional model whichseems more close to reality. We assume the stochastic variables are distributedanyway, which replaces the Brownian motion assumption. In chapter2, moreadequate way to aggregate is used when studying the foreclosure rate. With its help,more realistic result is found. In chapter3and4, the idea of screening is introducedinto our research. The micro structure of the mortgage market is studied in differentcircumstances.The following results are found. For the factors like the house price appreciation,interest rate or house rent cost that influence the investment decision of the mortgageapplicants, there is one point in them. Take the house price for example. If the houseprice appreciation is higher than that point, it is unrelated to the mortgage foreclosurerate. If the house price appreciation is lower than that point, it is negatively related tothe mortgage foreclosure rate. That point holds a positive relationship with theloan-to-value ratio.If banks are in perfect competition, optimists on future house price would like toapply for mortgages. On the other hand, pessimists on future house price would liketo save. The mortgage menu can be formed at last and the mortgage interest rate ispositively related to the mortgage loan-to-value ratio. There is more possibility thatthe optimists may choose higher loan-to-value ratio. If there is only one bank inmonopoly, the most pessimists on future house price would like to save as well as theperfect competition case. But for other people, things are different. Their choicesdepend on the reservation loan condition. If a person’s condition is preferred buy thebank, the person is chosen to be a mortgage applier. Other people buy house all by themselves. The loan menu is a part of the envelope of the reservation loan conditions.The loan interest rate is positively related to the loan-to-value ratio. Optimists chooselower loan-to-value ratios, while pessimists choose higher ones. In the perfectcompetition market, people’s choices reflect their willing, but in the monopoly case,the choices are only the result of bank’s profit pursue.Shortly after the crisis began, the mortgage related problem has been a hot point.The article makes a whole new study by modeling the problem with self-reformedfrictionless option model, successfully introducing heterogeneity into the homemortgage study and using the idea of screening in the mortgage study for the firsttime. After conquering a lot of technical difficulties, some basic results are given.Financial crisis caused by mortgage defaults is not for the first time even inAmerican history. The research on micro structure of mortgage market helps banks tomake better mortgages and helps the central banks to manage the banking systembetter. This research is still unsatisfying, and more heterogeneous factors might beconsidered. We take the different expectation as an example and benchmark for moredetailed and complete research in the future. At the same time, great deals of usefulrevelations come out after the research of the mortgage market micro structure.