An Analysis of Mortgage Termination Risks: A Shared Frailty Approach with MSA-Level Random Effects

James B. Kau, Donald C. Keenan and Xiaowei Li

Online First™, 5 May 2009

Abstract

Investigating the residential mortgage defaults and prepayments has been the subject of research for the past three decades. The literature on mortgage default and prepayment is often used to inform credit risk policies and asset pricing strategies. This literature has evolved from the use of logistic regressions to the use of survival and frailty models that control for unobserved heterogeneity. In this paper, we apply a shared-frailty survival model to analyze the mortgage termination risks. In particular, we investigate whether mortgages originated in the same Metropolitan Statistical Area (MSA) share common unobserved factors and how these factors affect the mortgage termination risks. The paper demonstrates that MSA-level frailty, together with other risk factors, has significant effects on the probability of mortgage terminations risks.Keywords  Mortgage termination – MSA – Shared-frailty effect

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