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Underpriced Default Spread Exacerbates Market CrashesWinston T.H. KohSingapore Management University - School of Economics & Social Sciences Roberto S. MarianoSingapore Management University Andrey D. PavlovSimon Fraser University (SFU) - Finance Area Sock Yong PhangSingapore Management University - School of Economics & Social Sciences Augustine H.H. TanSingapore Management University - School of Economics & Social Sciences Susan M. WachterUniversity of Pennsylvania - Wharton School, Department of Real Estate October 9, 2006 U of Penn, Inst for Law & Econ Research Paper No. 06-13 Abstract: In this paper, we develop a specific observable symptom of a banking system that underprices the default spread in non-recourse asset-backed lending. Using three different data sets for 18 countries and property types, we find that, following a negative demand shock, the "underpricing" economies experience far deeper asset market crashes than economies in which the put option is correctly priced. Furthermore, only one of the countries in our sample continues to exhibit the underpricing symptom following a market crash. This indicates that market crashes have a cleansing effect and eliminate underpricing at least for a period of time. This makes investing in such markets safer following a negative demand shock.
Number of Pages in PDF File: 34 Keywords: real estate bubble, lender optimism, disaster myopia, Asian financial crisis working papers seriesDate posted: June 23, 2006Suggested CitationContact Information
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