Self-Selection and Tests for Bias and Risk in Mortgage Lending: Can You Price the Mortgage If You Don't Know the Process?

Abstract

There is increasing interest in understanding the determinants of mortgage rejection by lenders and default by borrowers. Although many researchers have proposed simple single-equation models of rejection and default, we argue that far more complex econometric specifications are needed. This paper focuses attention on problems of sample selection in the process creating a sample of applicants for conventional mortgages. We illustrate that corrections for sample selection bias may have a substantial effect on estimation results and hence should not be ignored in studies of mortgage rejection or default.