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Risk Perception and Loan Underwriting in Securitized Commercial Mortgages

Simon Firestone, Nathan Y. Godin, Akos Horvath and Jacob Sagi ()
Additional contact information
Akos Horvath: https://www.federalreserve.gov/econres/akos-horvath.htm
Jacob Sagi: https://www.kenan-flagler.unc.edu/faculty/directory/jacob-sagi/

No 2024-019, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

Abstract: We use model-implied volatility to proxy for property risk perceptions in the commercial real estate lending market. Although loan-to-value ratios (LTVs) unconditionally decreased following the Global Financial Crisis, LTVs conditioned on implied volatility and other theoretically motivated fundamental determinants of optimal leverage show no conclusive trend before or after the crisis. Taking reported property and loan attributes at face value, we find no clear pattern of unwarranted credit being extended to commercial real estate assets. We conclude that systematically higher LTV decisions pre-crisis would have primarily stemmed from risk misperceptions rather than imprudent practices. Our findings suggest that the aggregate LTV level should be interpreted as a proxy for lending standards only after controlling for aggregate risk perceptions, among a host of asset and lending market factors. Our findings also highlight the importance of measuring and tracking aggregate risk perceptions in informing regulators and policymakers.

Keywords: Loan underwriting; Lending standards; Global Financial Crisis; Mortgages; Real estate finance; Implied volatility (search for similar items in EconPapers)
JEL-codes: C22 D80 G01 G10 G18 G21 R38 (search for similar items in EconPapers)
Pages: 53 p.
Date: 2024-04-10
New Economics Papers: this item is included in nep-ban, nep-rmg and nep-ure
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedgfe:2024-19

DOI: 10.17016/FEDS.2024.019

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