A policy perspective.

This paper analyzes credit risk for residential mortgages. Estimates of the hazard of mortgage default are presented, based upon a large sample of conventional loans issued in the late 1970s. Mean returns are estimated, together with variances and covariances for various loan-to-value (LTV) ratios and geographic groups. These results are then used to analyze capital requirements for institutions holding mortgages. We ask: For a given bankruptcy risk, how should capital requirements vary by LTV and geographical diversification? The empirical results indicate that both factors have powerful effects upon bankruptcy risk; thus capital requirements should vary substantially along these dimensions.