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Empirical analysis of the average asset correlation for real estate investment trusts

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Jose A. Lopez

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Abstract

The credit risk capital requirements within the current Basel II Accord are based on the asymptotic single risk factor (ASRF) approach. The asset correlation parameter, defined as an obligor's sensitivity to the ASRF, is a key driver within this approach, and its average values for different types of obligors are to be set by regulators. Specifically, for commercial real estate (CRE) lending, the average asset correlations are to be determined using formulas for either income-producing real estate or high-volatility commercial real estate. In this paper, the value of this parameter was empirically examined using portfolios of U.S. publicly traded real estate investment trusts (REITs) as a proxy for CRE lending more generally. CRE lending as a whole was found to have the same calibrated average asset correlation as corporate lending, providing support for the recent U.S. regulatory decision to treat these two lending categories similarly for regulatory capital purposes. However, the calibrated values for CRE categories, such as multifamily residential or office lending, varied in important ways. The comparison of calibrated and regulatory values of the average asset correlations for these categories suggest that the current regulatory formulas generate parameter values that may be too high in most cases.

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Paper provided by Federal Reserve Bank of San Francisco in its series Working Paper Series with number 2005-22.

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Date of creation: 2005
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Handle: RePEc:fip:fedfwp:2005-22

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This paper has been announced in the following NEP Reports: References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Michael B. Gordy, 1998. "A comparative anatomy of credit risk models," Finance and Economics Discussion Series 1998-47, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  2. Joseph Gyourko & Donald B. Keim, . "What Does the Stock Market Tell Us About Real Estate Returns? (Revision of 18-91) (Reprint 030)," Rodney L. White Center for Financial Research Working Papers 11-92, Wharton School Rodney L. White Center for Financial Research.
  3. Jackson, Patricia & Perraudin, William & Saporta, Victoria, 2002. "Regulatory and "economic" solvency standards for internationally active banks," Journal of Banking & Finance, Elsevier, vol. 26(5), pages 953-976, May. [Downloadable!] (restricted)
  4. Lopez, Jose A., 2004. "The empirical relationship between average asset correlation, firm probability of default, and asset size," Journal of Financial Intermediation, Elsevier, vol. 13(2), pages 265-283, April. [Downloadable!] (restricted)
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  5. Patric H. Hendershott & Charles W.R. Ward, 2002. "Valuing and Pricing Retail Leases with Renewal and Overage Options," NBER Working Papers 9214, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  6. Gordy, Michael B., 2003. "A risk-factor model foundation for ratings-based bank capital rules," Journal of Financial Intermediation, Elsevier, vol. 12(3), pages 199-232, July. [Downloadable!] (restricted)
  7. Mei, Jianping & Lee, Ahyee, 1994. "Is There a Real Estate Factor Premium?," The Journal of Real Estate Finance and Economics, Springer, vol. 9(2), pages 113-26, September.
  8. Joseph Gyourko & Donald B. Keim, 1992. "What Does the Stock Market Tell Us About Real Estate Returns?," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 20(3), pages 457-485. [Downloadable!] (restricted)
  9. Michael B. Gordy, 2002. "A risk-factor model foundation for ratings-based bank capital rules," Finance and Economics Discussion Series 2002-55, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  10. Bradford Case, 2003. "Loss characteristics of commercial real estate loan portfolios," Basel II White Paper 1, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  11. Gordy, Michael B., 2000. "A comparative anatomy of credit risk models," Journal of Banking & Finance, Elsevier, vol. 24(1-2), pages 119-149, January. [Downloadable!] (restricted)
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(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Ethan Cohen-Cole, 2007. "Asset liquidity, debt valuation and credit risk," Quantitative Analysis Unit Working Paper QAU07-5, Federal Reserve Bank of Boston. [Downloadable!]
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