The study of Ferguson and Shockley (2003) shows that, if the Merton (1974) model can reflect reality, the omission of debt claims from the market portfolio proxy may explain the poor pricing ability of the CAPM in empirical tests. We critically re-assess this argument by first reviewing existing, but also new avenues through which the Merton (1974) model can point to a systematic bias in market beta estimates. However, we also show that some avenues are diversifiable, and that they all rely on excessive economy-wide default risk to create a non-negligible bias. We then use the Merton (1974) model to proxy for the total debt portfolio, but find that its application in empirical tests cannot improve pricing performance. We conclude that there are (so far) no valid theoretical reasons to believe that omitted debt claims undermine CAPM tests.

This paper establishes a basic framework to study three different variants of Participating Mortgages (PMs). We obtain results for Shared Appreciation Mortgages (SAMs), Shared Income Mortgages (SIMs) and Shared Equity Mortgages (SEMs) in closed-form. We illustrate our findings with examples that show PMs are also attractive in an environment where prepayment can occur. Finally we conclude with the public policy implications of employing PMs as workout loans, especially post sub-prime crisis. We argue that by facilitating better risk sharing, PMs offer a means to enhance the efficiency and resiliency of the financial system.