Recent studies have emphasized the importance of consumption inequality. Compared with wage, income and wealth, consumption reflects the abundance of the life time resource of a household and is a more direct measure of economic welfare. To understand the determination of consumption inequality, the degree of consumption insurance is important: it determines how much income inequality is transmitted into consumption inequality. In the real world, income shocks are mitigated by a variety of insurance mechanisms. In economic theory, different hypotheses of market structure provide different levels of consumption insurance. Figuring out consumption insurance in the class of quantitative models and test the model hypotheses by the data is, in my view, an indispensable step towards our better understanding of consumption inequality.
We present a continuous time option pricing model for mortgage valuation to examine the effects of a prepayment penalty on the default and the prepayment decision of subprime borrowers. We show that the options embedded in the mortgage contract have significant positive values for the mortgage borrower. In particular, the value of the prepayment option for the subprime mortgage borrower is significant. The major finding from this study is that the prepayment penalty affects not only the prepayment decision but also the default decision of subprime borrowers, by reducing the value of these options. The prepayment penalty increases the likelihood of default by subprime borrowers and makes refinancing prohibitively costly. These two effects induced by the prepayment penalty generate a high rate of mortgage defaults and foreclosures. Consequently, borrower defaults began to increase as house prices started to depreciate in 2006.
We are in the middle of an economy-wide financial crisis with the subprime mortgage market at the epicenter of the crisis. The first sign of trouble was a sudden increase of default in the subprime mortgage market with a drastic house price depreciation in 2006. What caused this sudden increase in default rates in the subprime mortgage market after many years of high prepayment rates? This paper is an attempt to answer this question. This is of interest to academics, policy makers, and the general public.
Vietnam’s agrarian transition in the 1990s has closely followed a now classic policy scenario for economies in transition. First one privatizes the main productive assets in this case agricultural land-use rights then one legalizes their free exchange. In the first step, the de-collectivization of agriculture meant that the land that had been farmed collectively was to be allocated by administrative means within each commune. Naturally this left inefficiencies in land allocation, with some households having more land than they are likely to have had in a competitive market allocation, while some had less.
The second step was reforming land laws so as to create the framework for a free market in agricultural land-use rights. While land remained the property of the state, Vietnam reformed land laws in 1993 to introduce official land titles and permit land transactions for the first time. Having removed legal obstacles to buying and selling land-use rights, one might expect rapid transition to a more efficient market economy in which land was re-allocated to eliminate the initial inefficiencies in the administrative assignment.
