Explicit Tests of Contingent Claims Models of Mortgage Default

The Journal of Real Estate Finance and Economics

Volume 11, Issue 2, Article 1 (Abstract)


Explicit Tests of Contingent Claims Models of Mortgage Default


John M. Quigley and Robert Van Order


This paper provides explicit and powerful tests of contingent claims approaches to modeling mortgage default. We investigate

a model of “frictionless” default (i.e., one in which transactions costs, reputation costs, and moving costs play no role) and

analyze its implications-the relationship between equity and default, the timing of default, its dependence upon initial conditions,

and the severity of losses. Absent transactions costs and other market imperfections, economic theory makes well-defined

predictions about these various outcomes. The empirical analysis is based upon two particularly rich bodies of micro data: one

indicating the default and loss experience of all mortgages purchased by the Federal Home Mortgage Corporation (Freddie

Mac), and a large sample of all repeat sales of single family houses whose mortgages were purchased by Freddie Mac since



contingent claims, mortgage default, options models