Are real estate appraisals based on fundamentals that determine the value of the real estate or on offer price? Does this question really matter? In a game of moral hazard with hidden information, we examine an appraiser’s incentives in conducting an appraisal. We find that a moral hazard problem can arise if the mortgagee rewards the appraiser with future business for successful appraisals. An appraiser may be willing to overstate the value of a property if the lender wants him to do so. Additionally, we define the conditions under which the moral hazard problem actually makes all of the players better or no worse off. We argue that the subjective judgment of an appraiser may be Pareto improving. Thus, excessive regulation of the appraisal industry or finer tuned quantitative models that constrain subjective judgment may actually reduce the gains of real estate trade.
Journal of Property Investment & Finance – Emerald Publishing
Published: Jun 1, 2002
Keywords: Real estate; Valuations; Theory; Appraisal
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