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1、 J Real Estate Finance Econ (2009) 38:214240 DOI 10.1007/s11146-008-9151-1 Mortgage Prepayment and Default Behavior with Embedded Forward Contract Risks in Chinas Housing Market Yongheng Deng & Peng Liu Published online: 26 September 2008 # Springer Science + Business Media, LLC 2008 Abstract Most c
2、ondominiums in China are sold forward on a pre-sale market, where purchasers and developers transact on an underlying property that is not yet completed. During the pre-sale period home buyers face a significant forward contract risk. However, home buyers can borrow mortgages from banks so that they
3、 can effectively share the forward contract risk with banks. This explains the phenomenon of irregularly high early-stage default and prepayment rates observed in residential mortgage lending in China, where there are few, if any, financial incentives for mortgage borrowers to exercise either put or
4、 call options. Mortgages collateralized by forward housing assets are riskier than are those with underlying assets traded on the spot market. However, currently Chinese mortgage banks charge the same rate to all mortgage borrowers. This inefficiency in risk sharing between mortgage borrowers groups
5、 in the forward and spot housing markets leads to mispricing in secondary mortgage sales and mortgage-backed security trading. Keywords Mortgage . Prepayment . Default . Credit risk . Forward contract . Pre-sale JEL Classification G12 . G14 . G21 . H31 Introduction The residential mortgage market in
6、 China has grown rapidly since 1998, with an average annual growth rate of roughly 100%. By the end of the first quarter of 2005 Y. Deng University of Southern California, 650 Childs Way, RGL 201A, Los Angeles, CA 90089-0626, USA e-mail: ydengusc.edu P. Liu (*) Cornell University, 465 Statler Hall,
7、Ithaca, NY 14853, USA e-mail: pl333cornell.edu Mortgage Prepayment and Default Behavior with Embedded Forward. 215 the outstanding balance of residential mortgages reached 1.7 trillion RMB Yuan (Fig. 1), approximately USD 207 billion.1 There are two highly distinctive features of the Chinese mortgag
8、e market: First, the Peoples Bank of China (the central bank in China) sets the mortgage rate, which applies to all borrowers.2 Second, beyond the standard spot market for existing housing transactions, there is an active forward real estate market in the sense that the developer can sell a housing
9、unit before its completion, sometimes even before construction begins. A pre-sale practice that distinguishes Chinas housing market from other housing markets is the timing of the fund allocated to developers. In many housing markets around the world, the funds (which typically consist of a certain
10、percentage of the purchasing price of the property) are put into an escrow account and allocated to the developer gradually according to the progress made in building the development. In China, however, at least before 2007, funds are transferred to the project developer all at once. At the closing
11、time of such a pre-sale, the purchaser can either pay the pre-sale price in full or finance a certain amount (usually 80% of the purchasing price during the period of 1998 to 2003) from a bank. As a result, during the pre- sale3 period home buyers face a significant forward contract risk. However, s
12、ince home buyers in China are allowed to borrow a standard mortgage from a bank to finance such a pre-sale unit, home buyers in the pre-sale housing market share the forward contract risk with banks. This explains the phenomenon of irregularly high early-stage default and prepayment rates observed i
13、n residential mortgage lending in China, where there are few if any financial incentives for mortgage borrowers to exercise either put or call options. A consumer (home buyer) in Chinas forward housing market will choose to default her mortgage contract if the developer defaults the forward housing
14、contract. If the forward housing unit is delivered, the consumer may choose to prepay the loan depending on her liquidity constraints and returns through alternative investment channels. Because of the embedded risk of developer default, mortgages collateralized on pre-sold properties are more risky
15、 than their counterparts on the spot market are. Chinas pre-selling system is among its unique practices undertaken during economic reform as it transitions from a central planning economy to a market- oriented economy. Understanding the institutional differences in Chinas housing market not only he
16、lps us correctly adjust housing or mortgage pricing in these markets, but it also sheds light on studies of other financial puzzles in the emerging economy. This is particularly relevant given the size of Chinas economy and the trend towards global financial integration. This paper studies the compe
17、ting risks of mortgage prepayment and default with embedded forward contract risk of developers default. The economic model is based upon the Cox proportional hazard model of mortgage termination (Cox 1972, 1975). The empirical analysis is based upon a rich set of mortgage-lending data from 1 As of
18、March 2007 the exchange rate of Chinese Yuan (CNY) is one U.S. dollar=7.74 CNY. 2 There is a long history of not using risk-based interest rates in China or other central-planning economies. It is also a tradition that in those countries a unified product or service is provided to all consumers. 3 W
19、e use the terms forward market and pre-sell market interchangeably. 216 Y. Deng, P. Liu a leading mortgage lender in China. The loan history dataset contains not only mortgage loan characteristics, but also information about borrowers and developers. The unique dataset allows us to study mortgage bo
20、rrowers prepayment and default behavior with embedded forward contract risks. The finding of this study will provide valuable insights into emerging housing and mortgage markets in China as well as those in other transitional economies. The remainder of the paper is organized as follows. Section The
21、 Mortgage and Housing Markets in China describes the Chinese mortgage market in detail, including both the single mortgage rate constraint and the forward market for new units. Section The Data describes the data used in this study. Section The Empirical Model and Estimation Methodology lays out the
22、 empirical methodology. Section Empirical Results presents a discussion of the empirical results. A brief conclusion follows. The Mortgage and Housing Markets in China The long history of the real estate and consumer loan markets in China was transformed abruptly in 1949, when China adapted the cent
23、ral planning system. For a long period of time, under the central planning regime, housing in China had been treated as a social welfare product administrated and delivered by state agencies (e.g., state-owned enterprisesSOEsand housing bureaus) for its people. Under such a welfare-oriented system,
24、the private housing market and the residential mortgage system were extinguished. The mission of Chinese banks was to act as government-directed funding sources for SOEs. Since the early 1980s, China has gradually restructured its housing system. Market mechanisms, with the objectives of eliminating
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