Equilibrium Subprime Lending

Journal of Finance, Forthcoming

42 Pages Posted: 10 Apr 2010 Last revised: 30 Apr 2012

See all articles by Igor Makarov

Igor Makarov

London School of Economics & Political Science (LSE)

Guillaume Plantin

University of Toulouse 1 - Toulouse School of Economics (TSE)

Date Written: April 2012

Abstract

This paper develops an equilibrium model of a subprime mortgage market. The model is analytically tractable and delivers plausible orders of magnitude for borrowing capacities, loan-to-income ratios, home prices, and default and trading intensities. We offer simple explanations for several phenomena in the subprime market, such as the prevalence of “teaser rates” and the clustering of defaults. In our model, the degree of income co-movement among households plays an important role. We find that both systematic and idiosyncratic income risks reduce debt capacities, although through quite distinct channels, and that debt capacities and home prices need not be higher when a larger fraction of income risk is idiosyncratic.

Suggested Citation

Makarov, Igor and Plantin, Guillaume, Equilibrium Subprime Lending (April 2012). Journal of Finance, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1587388 or http://dx.doi.org/10.2139/ssrn.1587388

Igor Makarov (Contact Author)

London School of Economics & Political Science (LSE) ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

Guillaume Plantin

University of Toulouse 1 - Toulouse School of Economics (TSE) ( email )

Place Anatole-France
Toulouse Cedex, F-31042
France

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