The Supreme Subprime Myth: The Role of Bad Loans in the 2007-2009 Financial Crisis
PSL Quarterly Review, Vol. 65, No. 260, 2012
27 Pages Posted: 23 Aug 2011 Last revised: 11 Oct 2011
Date Written: October 7, 2011
Using simulations, we show that the probability of default and losses given default of subprime mortgage loans are small in comparison to their interest rates. The implication is that these loans are profitable for risk neutral efficient banks. As subprime mortgages remain a good investment even for higher values of probability of default and losses given default, our conclusion is that they did not trigger the 2007-2009 financial crisis. In contrast with other papers, this finding does not derive from analyses relating to the subprime market size, but from the positive ex-ante net present value of their discounted cash flows.
Keywords: subprime mortgages, interest rates, probability of default, loss given default
JEL Classification: G01, G11, G21, G32
Suggested Citation: Suggested Citation