Optimal put exercise: An empirical examination of conditions for mortgage foreclosure

Implicit in option-pricing models of mortgage valuation are threshold level s of put-option value that must be crossed to induce borrower default. Ther e has been little research into what these threshold values are that come o ut of pricing models or how they compare to exercised option values seen in empirical data. This study decomposes boundary conditions for optimal defa ult exercise to look at the economic dynamics that should lead to optimal d efault timing. Empirical data on FHA insured mortgage foreclosures is then examined to discern the predictive influence of optimal-option-valuation-an d-exercise variables on observed default timing and values. Interesting res ults include a new understanding of how to measure and use property equity variables during economic downturns, house-price index ranges over which de fault is exercised for various classes of borrowers, and implied difference s in appreciation rates between market-price indices and foreclosed propert ies.