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Effects of unobserved defaults on correlation between probability of default and loss given default on mortgage loans

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Author Info
Palmroos, Peter () (Bank of Finland Research)
Abstract

This paper demonstrates how the observed correlation between probability of default and loss given default depends on the fact that defaults in which collateral provides 100% recovery are not observed. Creditors see only the defaults of mortgagors who suffer from a fall in collateral value to less than the remaining loan principal. Consequently, the default data available to creditors amounts to a mere truncated sample from the underlying population of defaults. Correlation estimates based on such truncated samples are biased and differ substantially from estimates derived from representative non-truncated samples. Moreover, the observed correlation between default probability and loss given default is sensitive to the truncation point, which may explain the differences in correlation estimates found in the literature. This may also explain why correlation estimates seem to be specific to cycle phase.

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File URL: http://www.bof.fi/NR/rdonlyres/4014D355-08B7-4ED5-B6A1-7EF66E99D950/0/0903netti.pdf
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Publisher Info
Paper provided by Bank of Finland in its series Research Discussion Papers with number 3/2009.

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Length: 28 pages
Date of creation: 21 Jan 2009
Date of revision:
Handle: RePEc:hhs:bofrdp:2009_003

Contact details of provider:
Postal: Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland
Web page: http://www.bof.fi/en/tutkimus
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Related research
Keywords: credit risks; mortgage loans; truncated distributions; sample selection; log-normal distribution;

Find related papers by JEL classification:
C46 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Specific Distributions
E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Mortgages
G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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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. Campbell, Rachel A.J. & Forbes, Catherine S. & Koedijk, Kees G. & Kofman, Paul, 2008. "Increasing correlations or just fat tails?," Journal of Empirical Finance, Elsevier, vol. 15(2), pages 287-309, March. [Downloadable!] (restricted)
  2. Becchetti , Leonardo & Ciciretti , Rocco & Hasan, Iftekhar, 2009. "Corporate social responsibility and shareholder's value: an empirical analysis," Research Discussion Papers 1/2009, Bank of Finland. [Downloadable!]
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  3. Ambrose, Brent W & Buttimer, Richard J, Jr & Capone, Charles A, 1997. "Pricing Mortgage Default and Foreclosure Delay," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(3), pages 314-25, August.
  4. Sanjiv Das, 2007. "Basel II: Correlation Related Issues," Journal of Financial Services Research, Springer, vol. 32(1), pages 17-38, October. [Downloadable!] (restricted)
  5. Kau, James B, et al, 1992. "A Generalized Valuation Model for Fixed-Rate Residential Mortgages," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 24(3), pages 279-99, August. [Downloadable!] (restricted)
  6. David B. Gross, 2002. "An Empirical Analysis of Personal Bankruptcy and Delinquency," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 15(1), pages 319-347, March.
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This page was last updated on 2009-12-3.

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