Effects of unobserved defaults on correlation between probability of default and loss given default on mortgage loans
AbstractThis 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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Bibliographic InfoPaper provided by Bank of Finland in its series Research Discussion Papers with number 3/2009.
Length: 28 pages
Date of creation: 21 Jan 2009
Date of revision:
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; Micro Finance Institutions; Mortgages
- G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2009-02-14 (All new papers)
- NEP-RMG-2009-02-14 (Risk Management)
- NEP-URE-2009-02-14 (Urban & Real Estate Economics)
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