Primary Submission Category: Applications in Physical Sciences, Engineering, Environment and Miscellaneous Applications
Interference in Causal Inference into Household Mortgage Default Decisions
Authors: Walter Torous, William Torous,
Presenting Author: Walter Torous*
Strategic default theory argues that homeowners have an economic incentive to default when their home’s value falls below the amount owed on the property. Empirical evidence suggests that strategic defaults by homeowners were common during the Global Financial Crisis.
Recently, Ganong and Noel (GN) put forward a causal attribution methodology to investigate household mortgage default decisions and conclude that no defaults can be accounted for by strategic theory. Rather, all defaults are explained by homeowners’ inability to pay stemming from negative life events. These results have important policy implications as they suggest that any debt restructuring programs should focus on liquidity provision rather than principal reduction.
GN, however, ignore the possibility of interference in their causal attribution methodology. There is ample empirical evidence that observing others in foreclosure is an important determinant when considering the option to default yourself.
This paper explores the implications of contagion on GN’s causal attribution methodology. We do so by embedding a network model of neighborhoods that allows endogenous interactions among nearby neighbors to influence a homeowner’s likelihood of default.
We find that GN’s estimate of the share of defaults attributable to strategic theory is downward biased in the presence of contagion. The magnitude of the bias depends critically on neighborhood characteristics and can be significant.