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Abstract:
This research examines the implications of contingent claims models for empirical research on default. We focus on the probability of default over a short horizon given the current state of the world, i.e., the conditional probability of default, which more closely resembles the estimates of empirical models. We highlight the differences between the conditional and unconditional approaches and provide guidance for empirical research by illuminating situations where the expected sign reverses over the shorter horizon or where the functional form is highly non-linear.

Abstract:
In this study, we trace the impact of corporate focus by estimating the relationships of focus with cash flow and firm value. In contrast to past studies that examine the effects of diversifying across SIC code defined industries, we show, using Tobin's q, that diversification even within a single industry negatively affects value. Our evidence indicates that this value reduction is not due to poor managerial performance. Project level cash flows are actually higher for less focused firms. However, these gains are exactly offset by higher management, administrative and interest expenses. Thus the corporate cash flows available to shareholders are not related to focus. Finally, we provide empirical evidence that links the effect of focus on value to informational asymmetries which cause the equity of diversified firms to be less liquid.

Abstract:
This study investigates why externally advised Real Estate Investment Trusts (REITs) underperform their internally managed counterparts. Consistent with previous studies, we find that REITs managed by external advisors underperform internally managed ones by over 7% per year. Property-level cash flow yields are similar between the two managerial forms; but corporate-level expenses and especially interest expenses are responsible for lower levels of cash available to shareholders in externally advised REITs. We document that the higher interest expenses are due to both higher levels of debt and to higher debt yields for externally advised REITs. We posit that compensating managers based on either assets under management or on property level cash flows creates incentives for managers to increase the asset base by issuing debt even if the interest costs are unfavorable.

Abstract:
This study investigates why externally advised Real Estate Investment Trusts (REITs) underperform their internally managed counterparts. Consistent with previous studies, we find that REITs managed by external advisors underperform internally managed ones by over 7% per year. Property-level cash flow yields are similar between the two managerial forms; but corporate-level expenses and especially interest expenses are responsible for lower levels of cash available to shareholders (FFO) in externally advised REITs. We document that the higher interest expenses are due to both higher levels of debt and to higher debt yields for externally advised REITs. We posit that compensating managers based on either assets under management or on property level cash flows creates incentives for managers to increase the asset base by issuing debt even if the interest costs are unfavorable.

Abstract:
This research hypothesizes that in markets where information costs, transactions costs and the economic impact of information can vary widely, we should expect both significant predictability and systematic variation in the predictability. Controlling for other factors, we find that on average, 15-30% of the difference between the stock price and the estimated intrinsic value is removed in a year. We document that levels of predictability vary with firm characteristics like leverage, size and number of analysts. Momentum is stronger for larger firms with more analysts. Reversion to the intrinsic value is greater for smaller firms with more analysts.

Equity prices, momentum, reversion

Abstract:
In a growing economy the cash flows from investment projects can be expected to be rising over time. In this paper we explore the interactions of growth and uncertainty of cash flows with variable capital intensity in the decision to invest. We derive simple replacements for the usual neoclassical optimal investment rules based on IRR or NPV. We show that the ability to vary capital intensity raises the specter of perverse responses of investment to interest rates. Variable capital intensity is a sufficient condition for the perverse responses that can occur when growth rates are high or uncertainty is high. An empirical analysis of a panel data set on residential investment in the 1980sconfirms the predictions of the model and finds that about 40% of the observations fall in the positive response region.

Abstract:
This research analyzes the dynamic properties of the difference equation that arises when markets exhibit serial correlation and mean reversion. We identify the correlation and reversion parameters for which prices will overshoot equilibrium ("cycles") and/or diverge permanently from equilibrium. We then estimate the serial correlation and mean reversion coefficients from a large panel data set of 62 metro areas from 1979-1995 conditional on a set of economic variables that proxy for information costs, supply costs and expectations. Serial correlation is higher in metro areas with higher real incomes, population growth and real construction costs. Mean reversion is greater in large metro areas and faster-growing cities with lower construction costs. The average fitted values for mean reversion and serial correlation lie in the convergent oscillatory region but specific observations fall in both the damped and oscillatory regions and in both the convergent and divergent regions. Thus, the dynamic properties of housing markets are specific to the given time and location being considered.

dynamics, mean reversion, serial correlation, housing

Abstract:
We document that technical progress in originating and pricing mortgages has enabled a trend since 1979 toward more relaxed credit standards on mortgage lending, which is reflected in rising foreclosure rates. We then decompose annual variation in mortgage performance measured by share of loans entering foreclosure into a part due to economic conditions and a part due to underwriting changes. The decomposition provides natural metrics or indices of national underwriting quality and economic conditions. The results suggest that the recent subprime debacle can be attributed about equally to each factor. The deterioration since 1990 was marked by two periods. In the first, during the 1990s, there was a lowering of observable credit standards, like loan to value ratios. It was deliberate and related to the use of credit scores and the development of more sophisticated underwriting systems. The negative effects of eroding loan quality on foreclosures were to some extent masked by strong local and national economic conditions during this period. In the second period, after 2002, there was little change in observable loan characteristics like loan to value or credit history. This second period is associated with the rise of subprime and Alt-A markets but also with subprime and other "non-agency" securitization. Securitization induced moral hazard and a deterioration in underwriting standards that was not easily observed by investors in the securities.

Mortgages, subprime, house prices, banking

Abstract:
We explore the dynamics of real house prices by estimating serial correlation and mean reversion coefficients from a panel data set of 62 metro areas from 1979-1995. The serial correlation and reversion parameters are then shown to vary cross sectionally with city size, real income growth, population growth, and real construction costs. Serial correlation is higher in metro areas with higher real income, population growth and real construction costs. Mean reversion is greater in large metro areas and faster-growing cities with lower construction costs. Empirically, substantial overshooting of prices can occur in high real construction cost areas, which have high serial correlation and low mean reversion, such as the coastal cities of Boston, New York, San Francisco, Los Angeles and San Diego.

Abstract:
Technical progress in originating and pricing mortgages has enabled a trend since 1979 toward more relaxed credit standards on mortgage lending, which is reflected in rising foreclosure rates. We develop a methodology for decomposing the trend in mortgage performance in the national serviced portfolio into a part due to economic conditions and a part due to underwriting changes. The decomposition provides natural metrics or indices of underwriting quality and economic conditions. The results suggest that the recent mortgage debacle can be attributed about equally to each factor. The relaxation in observable credit standards is not monotonic. While the easing of important risk characteristics, like loan to value ratios, in the early 1990s was arguably deliberate, the negative effects of lower standards was masked by strong local and national economic conditions. After 2000, there was little change in observable loan characteristics; nevertheless, loan performance continued to erode even after controlling for the economic environment. We present evidence that the erosion in the latter period must have arisen from underwriting covariates that are typically unobservable to investors in securitizations. This evidence is consistent with the hypothesis that moral hazard in "non-agency" securitizations of mortgages, particularly subprime and Alt-A loans, caused underwriting risks to be mispriced.

mortgage, default, subprime, underwriting, foreclosure, risk management

Abstract:
This paper studies expectations of capital appreciation in the housing market. We show that expectations impounded in the rent/price ratio at the beginning of the decade successfully predict appreciation rates, but only if we first control for cross-sectional differences in the quality of rental versus owner-occupied housing. We also demonstrate that observed rent/price ratios contain a disequilibrium component that also has power to forecast subsequent appreciation rates. Finally, we provide evidence consistent with euphoria: participants in housing markets appear to overreact to income growth.

Abstract:
This paper studies expectations of capital appreciation in the housing market. We show that expectations impounded in rent-to-price ratio at the beginning of the decade successfully predict appreciation rates, but only if we first control for fluctuations within a transactions and information cost band. We also provide evidence of informational inefficiency: participants in housing markets appear to overreact to income growth and under-react to population growth in the prior decade.

Abstract:
This research hypothesizes that, in markets where information costs, transaction costs and the economic impact of information can vary widely, we should expect predictability to vary systematically. We test this hypothesis with data on equity real estate investment trusts (REITs) from 1985 to 1992. We document that levels of predictability vary with firm characteristics like leverage, size and focus. Momentum is stronger for larger, more levered REITs. Reversion is faster for focused, levered REITs. The results are consistent with the hypothesis that, in equilibrium, securities, where information is either less costly to acquire or has less impact on fundamental value, should exhibit less predictability.

Abstract:
When a mortgage borrower becomes seriously delinquent (i.e., defaults), the lender initiates a time consuming and complex recovery process that may or may not result in foreclosure and eventual disposition of the real estate collateral (REO). This research studies this transition process for a unique sample of subprime mortgages that were seriously delinquent on September 30, 2001. Eight months later, possible states for the delinquent loans, in order, are a) to remain delinquent without deteriorating further, 2) foreclosure, 3) worsen, i.e., become more months delinquent, 4) bankruptcy and 5) cure. The data indicate that, relative to prime loans, when subprime loans becomes seriously delinquent (90 days or longer) they are about twice as likely to become REO but take about four times longer to get there. It is unusual for a subprime defaults to be cured suggesting considerable forbearance by subprime lenders. We explore determinants of the transition probabilities and find that the most economically important predictors of transition from default to any other state are the number of payments the borrower has made and the loan to value ratio.

subprime, mortgages, defaults, losses, lending

Abstract:
We investigate relations among inside ownership, managerial expenses, risk sharing and equity valuations. Our engine of analysis - Real Estate Investment Trusts (REITs) - provides a unique and rich framework for analysis since we can calculate extremely accurate measures of asset replacement costs, and hence relative valuation (Tobin's Q). Further, the nature of the financial statements allows us to examine the impact of insider ownership on agency costs since we can accurately measure the costs of the entire management team. Our results show that firms with greater insider holdings tend to invest in assets with lower systematic risk and use less debt in their capital structure. At the same time, managerial expenses are lower as inside ownership increases. Finally, higher levels of insider ownership are associated with higher relative valuation as measured by both higher premiums to net asset value and higher multiples of cash flows. The results have implications for the design of optimal management contracts for both REITs and firms in general.

Abstract:
We explore the role of expected cash flow volatility as a determinant of dividend policy both theoretically and empirically. Our simple one period model demonstrates that, given the existence of a stock-price penalty associated with dividend cuts, managers rationally pay out lower levels of dividends when future cash flows are less certain. The empirical results use a sample of REITS from 1985-1992 and confirm that payout ratios are lower for firms with higher expected cash flow volatility as measured by leverage, size and property level diversification. These results are consistent with information-based explanations of dividend policy but not with agency cost theories.

Abstract:
A firm can be viewed as a portfolio of projects arising from capital budgeting decisions. How these projects are bundled, i.e. managerial style, affects administrative costs and firm value. We analyze the effect of style on firm value using a panel data set of 75 publicly-traded REITs over eight years. We partition general and administrative (G&A) expenses into that portion attributable to management "style" and a residual component. The style component is significantly related to the focus, size and debt of the firm. Though both components are significantly negatively related to market value, style-related components have a five-fold greater impact. We conclude that reorganizing into larger, more focused, less levered trusts would result in substantial value-added.

Abstract:
Drawing from a large mortgage loan database and an extensive panel data set on metropolitan areas, this study refines the contingent claims model of default. Recent research has treated default as optimal exercise of a put option and has emphasized loan to value ratios, loan age and interest rate measures. Transactions costs and trigger events like unemployment and divorce should also play a role in optimal default; but the importance of these costs have become contentious. The results confirm the statistical significance of each of these variables; however, the economic importance of transactions costs and trigger events is definitely secondary to the frictionless options model variables. By analyzing the data at both the metro area level and the regional level, we show that one reason other studies have found conflicting results is low statistical power arising from highly aggregated data and/or short sample periods.

Abstract:
This research assesses the impact of income and property taxes on house prices using a decadal panel data set for 63 metropolitan areas from 1970 to 1990. We find that marginal income and property tax rates are fully capitalized into house prices and explain a significant proportion of the regional variation in house prices. Applying the results to proposed tax changes, we show that removal of the interest and property tax deduction will reduce the average house price by 14% and could result in house price declines of up to 30% in some locations.

Abstract:
This study documents the wide deviations of securitized real estate assets in equity REITs from the value of the underlying commercial properties. The net asset value of REITs is estimated and used to investigate the sources of premiums/discounts from net asset value in a large sample of equity REITs. To avoid measurement error bias, two-way analysis of variance is used to test for differences among size and property-type categories. The results indicate that retail REITs traded at significant premiums relative to the average REIT while warehouse/industrial REITs traded at discounts and small REITs traded at significant discounts while large REITs traded at premiums. The discounts and premiums from net asset value do not translate into higher cash flow yields.

Abstract:
This research assesses the impact of income and property taxes on house prices using a decadal panel data set for 63 metropolitan areas from 1970 to 1990. Our evidence is consistent with full capitalization of marginal income tax rates into house prices. Full capitalization suggests that income tax changes have limited effects on the allocation of real capital among structure types, implying that past changes in the tax advantages have had little impact on home ownership and housing investment, in contrast to the conclusions of much of the existing literature. When we apply the results to some proposed tax changes, we compute substantial house price declines and wide geographic variation.

Abstract:
In this study, we explore the role of expected cash flow volatility as a determinant of dividend policy. We first demonstrate that returns are increasing in dividend payout. But, we show that responses to changes in dividends are less sensitive to the magnitude of the change than to the sign of the change. We next develop a simple two period model which demonstrates that, given the existence of a large stock price penalty associated with dividend cuts. Managers rationally pay out lower levels of dividends when future cash flows are less certain. Our final empirical results show that payout ratios are lower for those firms that are smaller, more levered and less diversified. This result is consistent with information based explanations but not with agency cost theories.