How Big are the Ambiguity-Based Premiums on Mortgage Insurances?

How Much Are Borrowers Willing to Pay to Remove Uncertainty Surrounding Mortgage Defaults?

“…The subject of Ambiguity Aversion has not received much attention in the real estate literature. The paper closest to ours is Chen and Chang’s ( 2019 ) study of the effect of insurer’s Ambiguity Aversion on the pricing of mortgage insurance. The authors find that Ambiguity Aversion is associated with increases in mortgage insurance premiums, an effect that increases with higher LTV.…”

“…The evidence overwhelmingly supports Ellsberg’s finding that people dislike ambiguity and will incur significant costs to avoid situations with uncertain payoffs while in the gain domain. The insights of Ambiguity Aversion in the gain domain help explain real-world phenomena such as when investors choose to exercise stock options (Izhakian and Yermack 2017 ), equity portfolio puzzles including poor portfolio diversification (Bossaerts et al 2010 ; Dimmock et al 2016 ; Bianchi and Tallon 2018 ; Peijnenburg 2018 ), the equity premium puzzle (Maenhout 2004 ; Collard et al 2018 ; Gollier 2011 ; Ju and Miao 2012 ), the stock market participation puzzle (Dow and Werlang 1992 ; Easley and O’Hara 2009 ), and mortgage insurance premiums (Chen and Chang 2019 ). Recent research though calls into question Ambiguity Aversion’s influence in the loss domain.…”

“…Golman and Loewenstein ( 2018 ) explain that Ambiguity Aversion is context specific. Chen and Chang ( 2019 ) examined the role of Ambiguity Aversion in insurers’ pricing of mortgage insurance; however, no study has applied Ambiguity Aversion to the extremely uncertain environment of borrower decisions surrounding mortgage defaults. We view this as a unique opportunity to understand decision making in an understudied region of the loss domain - extreme losses.…”