Financial Development and Property Valuation

Sikandar Hussain and M. Shahid Ebrahim ()

No 24, Computing in Economics and Finance 2005 from Society for Computational Economics

Abstract: This paper investigates the impact of financial development on property valuation in a rational expectations framework by modeling the agency theoretic perspective of risk averse investors (property owners) and financiers (banks/ capital markets). In contrast to previous research, we consider a setting in which financiers possess no inherent information processing or monitoring advantages. We demonstrate that property financing is undertaken in a pecking order of increasing pareto-efficiency (with reduction in its overall costs and a subsequent increase in the value of the underlying collateral) in a three staged process as financial architecture advances from a partially liberalized bank to the developed stage of capital markets. The primary solution is obtained in the rudimentary stage of commercial banks (in a specialized banking system), where the default-free mortgages are pareto-optimal to defaulting mortgages in accordance with the prognosis of Scott (1976) and Stulz and Johnson (1985). A pareto-improvement of the first solution is obtained by removing the restriction on ownership of property for financiers such as universal banks and pension funds, insurance companies, etc. This solution resolves the real estate version of the asset location puzzle (see Geltner and Miller, 2001). A further pareto-enhancement of this equilibrium is obtained under financial innovation by embedding the above default-free mortgage with options (in the form of a participating mortgage) in accordance with the prognosis of Green (1984), Haugen and Senbet (1981, 1987) and Schnabel (1993). Our results yield implications for financial system development. Our analysis predicts that an optimal financial system will configure itself skewed towards capital markets irrespective of the source of its origination (from specialized banking system or universal banking system). We also rationalize the co-existence of banks and financial markets in a well-developed financial system

Keywords: Financial Deepening; Financial Innovation; Financial Liberalization; Pareto-optimal Mortgage Design; Risk Management. (search for similar items in EconPapers)
JEL-codes: D58 G12 G2 G32 (search for similar items in EconPapers)
Date: 2005-11-11
New Economics Papers: this item is included in nep-cfn, nep-fin, nep-fmk and nep-ure
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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