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Problem 3 (10 Marks)
Problem3(10Marks)
Relative to the United Kingdom, the United States has borrower friendly laws surrounding residential mortRelativetotheUnitedKingdom,theUnitedStateshasborrowerfriendlylawssurroundingresidentialmortgage default. Many US states are Non-Recourse—that is, if borrowers stop making the mortgage payments,
gagedefault.ManyUSstatesareNon-Recoursethatis,ifborrowersstopmakingthemortgagepayments,
lenders cannot hold them responsible beyond seizing the home itself. On the other hand, the United Kinglenderscannotholdthemresponsiblebeyondseizingthehomeitself.Ontheotherhand,theUnitedKingdom has Full-Recourse : lenders may seize cars, investments, garnish wages, et cetera. Many believe that the
domhasFull-Recourse:lendersmayseizecars,investments,garnishwages,etcetera.Manybelievethatthe
relative leniency of laws in the United States is responsible for higher rates of mortgage default.
relativeleniencyoflawsintheUnitedStatesisresponsibleforhigherratesofmortgagedefault.
For the sake of simplicity, assume laws may take only two forms: Non-Recourse (in the United States)
Forthesakeofsimplicity,assumelawsmaytakeonlytwoforms:Non-Recourse(intheUnitedStates)
or Full-Recourse (in the United Kingdom). Imagine we are interested in the causal (treatment) effect of
orFull-Recourse(intheUnitedKingdom.Imagineweareinterestedinthecausal(treatment)effectof
Non-Recourselawsonmortgagedefault.
Non-Recourse laws on mortgage default.
(a) Denote mortgage default for a borrower i by D i . In potential outcomes notation, write the average
(a)DenotemortgagedefaultforaborroweribyDi.Inpotentialoutcomesnotation,writetheaverage
treatment effect of Non-Recourse laws on default. (3 marks)
treatmenteffectofNon-Recourselawsondefault.(3marks)
(b) Suppose we compare the average default rates in the United States to the average default rates in the
(b)SupposewecomparetheaveragedefaultratesintheUnitedStatestotheaveragedefaultratesinthe
United Kingdom. Write this comparison in potential outcomes notation. (3 marks)
UnitedKingdom.Writethiscomparisoninpotentialoutcomesnotation.(3marks)
(c) Why does the expression in part (a) differ from that in part (b)? Please provide an explanation that is
(c)Whydoestheexpressioninpart(a)differfromthatinpart(b)?Pleaseprovideanexplanationthatis
not simply mathematical, but that provides some intuition. Would you expect the answer in (b) to be
notsimplymathematical,butthatprovidessomeintuition.Wouldyouexpecttheanswerin(b)tobe
higher or lower than that in (a)? Why? (4 marks)
higherorlowerthanthatin(a)?Why?(4marks)
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