What Drives Default and Prepayment on Subprime Auto Loans?

This is the Author's Final Draft. The original published version is available at: http://dx.doi.org/10.1023/B:REAL.0000044023.02636.e6.This paper uses novel data on the performance of loan pools underlying asset backed securities to estimate a competing risks model of default and prepayment on subprime automobile loans. We find that prepayment rates increase rapidly with loan age but are not affected by prevailing market interest rates. Default rates are much more sensitive to aggregate shocks than are prepayment rates. Increases in unemployment precede increases in default rates, suggesting that defaults on subprime automobile loans are driven largely by shocks to household liquidity. There are significant differences in the default and prepayment rates faced by different subprime lenders. Those lenders that charge the highest interest rates experience the highest default rates, but also experience somewhat lower prepayment rates. We conjecture that there is substantial heterogeneity among subprime borrowers, and that different lenders target different segments of the subprime market. Because of their higher default rates, loans that carry the highest interest rates do not appear to yield the highest expected returns