Empirical Analysis of the Average Asset Correlation for Real Estate Investment Trusts

FRB of San Francisco Working Paper No. 2005-22

34 Pages Posted: 7 Dec 2005

See all articles by Jose A. Lopez

Jose A. Lopez

Federal Reserve Bank of San Francisco

Date Written: October 2005

Abstract

The credit risk capital requirements within the current Basel II Accord are based on the asymptotic single risk factor (ASRF) approach. The asset correlation parameter, defined as an obligor's sensitivity to the ASRF, is a key driver within this approach, and its average values for different types of obligors are to be set by regulators. Specifically, for commercial real estate (CRE) lending, the average asset correlations are to be determined using formulas for either income-producing real estate or high-volatility commercial real estate. In this paper, the value of this parameter was empirically examined using portfolios of U.S. publicly traded real estate investment trusts (REITs) as a proxy for CRE lending more generally. CRE lending as a whole was found to have the same calibrated average asset correlation as corporate lending, providing support for the recent U.S. regulatory decision to treat these two lending categories similarly for regulatory capital purposes. However, the calibrated values for CRE categories, such as multifamily residential or office lending, varied in important ways. The comparison of calibrated and regulatory values of the average asset correlations for these categories suggest that the current regulatory formulas generate parameter values that may be too high in most cases.

Suggested Citation

Lopez, Jose Antonio, Empirical Analysis of the Average Asset Correlation for Real Estate Investment Trusts (October 2005). FRB of San Francisco Working Paper No. 2005-22. Available at SSRN: https://ssrn.com/abstract=864604 or http://dx.doi.org/10.2139/ssrn.864604

Jose Antonio Lopez (Contact Author)

Federal Reserve Bank of San Francisco ( email )

101 Market Street
San Francisco, CA 94105
United States
415-977-3894 (Phone)
415-974-2168 (Fax)

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