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Financial Development and Property Valuation

Author

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  • Sikandar Hussain
  • M. Shahid Ebrahim

Abstract

This paper investigates the impact of financial development on property valuation in a rational expectations framework by modeling the agency theoretic perspective of risk averse investors (property owners) and financiers (banks/ capital markets). In contrast to previous research, we consider a setting in which financiers possess no inherent information processing or monitoring advantages. We demonstrate that property financing is undertaken in a pecking order of increasing pareto-efficiency (with reduction in its overall costs and a subsequent increase in the value of the underlying collateral) in a three staged process as financial architecture advances from a partially liberalized bank to the developed stage of capital markets. The primary solution is obtained in the rudimentary stage of commercial banks (in a specialized banking system), where the default-free mortgages are pareto-optimal to defaulting mortgages in accordance with the prognosis of Scott (1976) and Stulz and Johnson (1985). A pareto-improvement of the first solution is obtained by removing the restriction on ownership of property for financiers such as universal banks and pension funds, insurance companies, etc. This solution resolves the real estate version of the asset location puzzle (see Geltner and Miller, 2001). A further pareto-enhancement of this equilibrium is obtained under financial innovation by embedding the above default-free mortgage with options (in the form of a participating mortgage) in accordance with the prognosis of Green (1984), Haugen and Senbet (1981, 1987) and Schnabel (1993). Our results yield implications for financial system development. Our analysis predicts that an optimal financial system will configure itself skewed towards capital markets irrespective of the source of its origination (from specialized banking system or universal banking system). We also rationalize the co-existence of banks and financial markets in a well-developed financial system

Suggested Citation

  • Sikandar Hussain & M. Shahid Ebrahim, 2005. "Financial Development and Property Valuation," Computing in Economics and Finance 2005 24, Society for Computational Economics.
  • Handle: RePEc:sce:scecf5:24
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    File URL: http://repec.org/sce2005/up.17837.1104143478.pdf
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    References listed on IDEAS

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    Cited by:

    1. Tony Addison & Atanu Ghoshray & Michalis P. Stamatogiannis, 2016. "Agricultural Commodity Price Shocks and Their Effect on Growth in Sub-Saharan Africa," Journal of Agricultural Economics, Wiley Blackwell, vol. 67(1), pages 47-61, February.

    More about this item

    Keywords

    Financial Deepening; Financial Innovation; Financial Liberalization; Pareto-optimal Mortgage Design; Risk Management.;

    JEL classification:

    • D58 - Microeconomics - - General Equilibrium and Disequilibrium - - - Computable and Other Applied General Equilibrium Models
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G2 - Financial Economics - - Financial Institutions and Services
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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