The effects of market imperfections on mortgage terminations are evaluated. Market imperfections are characterized with the absence of labor income insurance and the existence of trading frictions such as transaction costs, information costs, agency costs, tax distortions, investment lumpiness. Mortgage terminations are modeled as portfolio selections over risky illiquid housing assets and risk-free liquid money market accounts.
Agents are heterogeneous and are distinguished from each other by financial status and preferences.
Preferences are specified to include risk aversion and satisfaction over wealth accumulation and homeownership. Falling aggregate economic growth and rising individual earnings uncertainties reduce mortgage values significantly by increasing the likelihood of default as the liquidity constraint is more likely to bind. Homeownership satisfaction and risk aversion lower default risks. Default risks pose a larger threat to mortgage values than prepayment risks. Trading frictions are important but their significance is overshadowed by the absence of income insurance and mortgagors' preferences.