The supreme subprime myth: the role of bad loans in the 2007-2009 financial crisis
Keywords:subprime mortgages, interest rates, probability of default, loss given default.
Using simulations, we show that the probability of default and losses given default of subprime mortgage loans are small in comparison to their interest rates. The implication is that these loans are profitable for risk neutral efficient banks. As subprime mortgages remain a good investment even for higher values of probability of default and losses given default, our conclusion is that they did not trigger the 2007-2009 financial crisis. In contrast with other papers, this finding does not derive from analyses relating to the subprime market size, but from the positive ex-ante net present value of their discounted cash flows.
JEL Codes: G01, G11, G21, G32.
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