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Working Paper 2008-039B

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"Did Prepayments Sustain the Subprime Market?"
by Geetesh Bhardwaj, and Rajdeep Sengupta

Using loan-level data on subprime mortgages, we present evidence on the uniqueness of subprime mortgage design. We show that the viability of such products was predicated on the appreciation of house prices. In a regime of rising house prices, a borrowers avoided default by prepaying the loan. However, a sudden reversal in house price appreciation increased default in this market because it made this prepayment exit option cost-prohibitive. Most important, both delinquent and non-delinquent borrowers used early prepayments as exit options. This paper shows that high early defaults on post-2004 originations can be explained when one takes into account the high early prepayment rates for the pre-2004 vintages.

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Category > Applied Microeconomics
Category > Finance
Author > Rajdeep Sengupta