Academic journal article IUP Journal of Applied Economics

Asymmetric Volatility Transmission between Home Foreclosures, Housing Prices, Unemployment Rate and Adjustable Mortgage Rates

Academic journal article IUP Journal of Applied Economics

Asymmetric Volatility Transmission between Home Foreclosures, Housing Prices, Unemployment Rate and Adjustable Mortgage Rates

Article excerpt

(ProQuest: ... denotes formulae omitted.)

Introduction

The mortgage crisis in the US which started in 2007 has been blamed on excess of subprime mortgage loans, low mortgage rates, inflow of foreign capital into mortgage-backed securities, relaxed credit standards, greed, lenders' disregard for risk management, lack of regulatory oversight, and inflated housing prices. Between 2003 and 2004, mortgage rates reached historic lows and house prices skyrocketed. The mortgage crisis, coupled with massive household debts, high loan-to-value ratios caused the economy to slip into a deep recession. The subprime debacle led to severe liquidity crisis as a result of deterioration in the balance sheets of most lending institutions. As a result of the subprime crisis, most financial institutions tightened their credit standards. Household financial crisis, high unemployment rate and long duration of unemployment all contributed to an increase in the supply of existing houses in the market. Consequently, house prices fell despite low mortgage rates and loan modification programs introduced by the federal government. To restore stability in the real estate market, the federal government bailed out some of the troubled-institutions through the Troubled Asset Relief Program (TARP).

The subprime crisis has attracted the attention of economists and analysts given its implications for the US economy. Most of the studies have concentrated on either the impact of foreclosures on property values or on the relationship between foreclosures and crimes. The present study, however uses the EGARCH model developed by Nelson (1991) to examine the asymmetric relationships between foreclosures, housing prices, unemployment rate and adjustable mortgage rates.

Literature Review

Gerardi et al. (2009) suggested that the foreclosure crisis was primarily caused by the severe decline in housing prices that began in the latter part of 2005. They further pointed out that relaxed underwriting standards severely aggravated the crisis by creating a class of home owners who were particularly vulnerable to the decline in prices. Foote et al. (2008) maintained that defaults on subprime adjustable-rate mortgages are more sensitive to declining housing prices than are defaults on fixed-rate loans. Pennington-Cross and Ho (2010) using a multinomial logit model examined the impact of foreclosure proceedings on subprime mortgage market. They adopted the multinomial logit model because it allows for the interdependence of the possible outcomes or risks (cure, partial cure, paid off, and real estate owned) through the correlation of associated unobserved heterogeneities. They find that the duration of foreclosures is impacted by many factors including contemporaneous housing market conditions, the prior performance of the loan (prior delinquency), and the state-level legal environment.

Lippman (2009) suggested that the current environment, declining housing prices, tight credit and growing public concern are among the factors that made foreclosures less attractive, particularly in the case of primary residence. Immergluck (2009) contends that subprime lenders achieved greater market penetration in metropolitan areas with less educated residents. Gwartney and Connors (2009) noted that both the housing and lending markets are affected by factors such as policies on lending standards and down payments. Schuetz et al. (2008) used a unique dataset on property sales and foreclosure filings in New York city from 2000 to 2005 to identify the effects of foreclosure that starts on housing prices in the surrounding neighborhood. They found that, above some threshold, proximity to properties in foreclosure is associated with lower sales prices. The magnitude of the price discount increases with the number of properties in foreclosure.

Leonard and Murdoch (2009) found that foreclosures have adverse effects on the quality of neighborhoods. Based on the results of their study, they conclude that nearby foreclosures produce negative externalities that depress home prices. …

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