Home Energy Efficiency and Mortgage Risks: Research funded by the Institute for Market Transformation

Many have theorized that energy efficient homes should have lower default risks than standard homes because the former are associated with lower energy costs, which leaves more money to make the mortgage payment. However, few empirical studies have been conducted due to limited data availability. This study examines actual loan performance data obtained from CoreLogic, the lending industry's leading source of such data. To assess whether residential energy efficiency is associated with lower default and prepayment risks, a national sample of about 71,000 ENERGY STAR- and non-ENERGY STAR-rated single-family home mortgages was carefully constructed, accounting for loan, household, and neighborhood characteristics.The study finds that default risks are on average 32 percent lower in energy-efficient homes, controlling for other loan determinants. This finding is robust, significant, and consistent across several model specifications. A borrower in an ENERGY STAR residence is also one-quarter less likely to prepay the mortgage. Within ENERGY STAR-rated homes, default risk is lower for more energy-efficient homes. The lower risks associated with energy efficiency should be taken into consideration when underwriting mortgages

Default contagion risks in Russian interbank market

Systemic risks of default contagion in the Russian interbank market are investigated. The analysis is based on considering the bow-tie structure of the weighted oriented graph describing the structure of the interbank loans. A probabilistic model of interbank contagion explicitly taking into account the empirical bow-tie structure reflecting functionality of the corresponding nodes (borrowers, lenders, borrowers and lenders simultaneously), degree distributions and disassortativity of the interbank network under consideration based on empirical data is developed. The characteristics of contagion-related systemic risk calculated with this model are shown to be in agreement with those of explicit stress tests.Comment: Final version, to appear in Physica

Pricing the Risks of Default

This paper characterizes the risk neutral jump process of default in terms of two entities, i) an instantaneous arrival rate of default and ii) a conditional density of the magnitude of the proportionate reduction in the value of creditors claims. The authors propose models for default arrival and magnitude risks as functions of evolving economic information. These two default components are then explicitly priced in the futures market with the spot price of risky debt being derived as a consequence. The resulting models for default arrival and magnitude risks are estimated on monthly data for rates on certificates of deposit offered by institutions in the Savings and Loan Industry. The data period is January 1987 to December 1991. The default arrival rate is modeled as responsive to abnormal equity returns, while default magnitude risk is modeled to be sensitive to the level of core deposits and the yield on low grade bonds. The authors' empirical results for the arrival and magnitude risk models provide strong support for the hypothesis that uninsured depositors place market discipline on the depository institutions by demanding compensation for both forms of the firm's default risks.

Managing subnational credit and default risks

As a result of worldwide decentralization, subnational debt is rising. Subnational debt crises in major developing countries in the 1990s have led to strengthened regulatory frameworks for subnational borrowing and insolvency. With the fragility of the global recovery and increasing public debt, and the structural trends of decentralization and urbanization, it becomes more important to prudently manage subnational default risks. Although the regulatory frameworks share central features, the historical context and entry points for reform drive variations across countries. Addressing soft budget constraints is integral to the regulatory framework. Ex ante fiscal rules for subnational governments attempt to limit default risks; ex post regulation predictably allocates default risk, while providing breathing space for orderly debt restructuring and fiscal adjustment, as well as the continued delivery of essential public services. The regulatory reforms are inseparable from the reform of broader intergovernmental fiscal systems and financial markets.Bankruptcy and Resolution of Financial Distress,Debt Markets,Access to Finance,Banks&Banking Reform,Subnational Economic Development

Handling Default Risks in Microfinance: The Case of Bangladesh

Despite the current enthusiasms in applying the concept of microfinance as a poverty alleviation tool in many countries, the risk management aspects of microfinancing should not be overlooked. This paper highlights several incidences of default risks in microfinance and subsequently, provides a comprehensive exploratory study on the various ways to handle the default risks in microfinance. While there are social and religious objectives embedded in extending microfinancing, fact is that the financiers are business entities having the objectives of maximizing returns and minimizing losses. In this regard, this paper contributes towards a more effective recovery process, so that more people can benefit from the microfinancing facilities. Several suggestions are highlighted to maximize the benefits of microfinance to both the creditors and borrowers with the objective of realizing a win-win situation for both parties.Microfinance, default risks, recovery process, Bangladesh

Multiple defaults and contagion risks

We study multiple defaults where the global market information is modelled as progressive enlargement of filtrations. We shall provide a general pricing formula by establishing a relationship between the enlarged filtration and the reference default-free filtration in the random measure framework. On each default scenario, the formula can be interpreted as a Radon-Nikodym derivative of random measures. The contagion risks are studied in the multi-defaults setting where we consider the optimal investment problem in a contagion risk model and show that the optimization can be effectuated in a recursive manner with respect to the default-free filtration

Multiple defaults and contagion risks

We study multiple defaults where the global market information is modelled as progressive enlargement of filtrations. We shall provide a general pricing formula by establishing a relationship between the enlarged filtration and the reference default-free filtration in the random measure framework. On each default scenario, the formula can be interpreted as a Radon-Nikodym derivative of random measures. The contagion risks are studied in the multi-defaults setting where we consider the optimal investment problem in a contagion risk model and show that the optimization can be effectuated in a recursive manner with respect to the default-free filtration.

Do CDS spreads reflect default risks? Evidence from UK bank bailouts

CDS spreads are generally considered to reflect the credit risks of their reference entities. However, CDS spreads of the major UK banks remained relatively stable in response to the recent credit crisis. We suggest that this can be explained by changes in loss given default (LGD). To obtain the result we first derive the probabilities of default from stock option prices and then determine the LGD consistent with actual CDS spreads. Our results reveal a significant decrease in the LGD of bailed out banks over the observed period in contrast to banks which were not bailed out and non-financial companies