Theory of the Credit Surface
Instead of focusing on the risk-free interest rate, market participants and policymakers would be better off tracking the spread faced by borrowers when taking out mortgages. Given a FICO score, a household desiring a certain loan-to-value ratio would be charged an interest rate higher than the risk-free rate, albeit how much higher depends on the ambient environment of the economy including expectation of house price appreciation and the likelihood of default. We present a theoretical model of the credit surface which maps to the data and show the role played by economic objects other than the risk-free rate in determining what the interest on your mortgage ought to be.
Joint with John Geanakoplos (draft coming Summer 2019!)
What role did expectations play in driving up house prices in the early-2000s and what triggered the subsequent bust in the U.S. housing market. Could debt forgiveness have mitigated the collapse of housing prices? I explore these questions in a structural macroeconomic model without hard collateral constraints using the credit surface to ease the problem of mortgage design.
(Work in progress)