2011/11/22 by Graham Andersen, Andersen, Graham, David Chisholm +1
Economics, Econometrics and Finance · #Housing Market and Economics
paper · pdf · doi:10.48550/arxiv.1111.5397
The writers propose a mathematical Method for deriving risk weights which\ndescribe how a borrower's income, relative to their debt service obligations\n(serviceability) affects the probability of default of the loan.\n The Method considers the borrower's income not simply as a known quantity at\nthe time the loan is made, but as an uncertain quantity following a statistical\ndistribution at some later point in the life of the loan. This allows a\nprobability to be associated with an income level leading to default, so that\nthe relative risk associated with different serviceability levels can be\nquantified. In a sense, the Method can be thought of as an extension of the\nMerton Model to quantities that fail to satisfy Merton's 'critical' assumptions\nrelating to the efficient markets hypothesis.\n A set of numerical examples of risk weights derived using the Method suggest\nthat serviceability may be under-represented as a risk factor in many mortgage\ncredit risk models.\n