Underpriced Lending and Real Estate Markets

Pavlov, Andrey D.; Wachter, Susan M.

doi:10.2139/ssrn.980298

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Underpriced Lending and Real Estate Markets

26 Pages Posted: 15 Apr 2007

See all articles by Andrey D. Pavlov

Andrey D. Pavlov

Simon Fraser University (SFU) - Finance Area

Susan M. Wachter

University of Pennsylvania - Wharton School, Department of Real Estate ; University of Pennsylvania - Finance Department

Date Written: December 20, 2006

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.

Keywords: real estate bubble, lender optimism, disaster myopia, Asian financial crisis

JEL Classification: G21

Suggested Citation: Suggested Citation

Pavlov, Andrey D. and Wachter, Susan M., Underpriced Lending and Real Estate Markets (December 20, 2006). Available at SSRN: https://ssrn.com/abstract=980298 or http://dx.doi.org/10.2139/ssrn.980298