Document Type

Article

Language

eng

Format of Original

11 p.

Publication Date

12-2003

Publisher

Institutional Investor, Inc.

Source Publication

Journal of Fixed Income

Source ISSN

1059-8596

Abstract

Term default and balloon risk play an interactive role in the pricing of credit risk in commercial mortgages. Most commercial mortgage pricing studies assume a borrower's default decision is based solely on the property value; the mortgage valuation model here also incorporates a property income trigger. The model considers both the risk of default during the term of the loan and the risk of loss at maturity (balloon risk). Monte Carlo simulation analyses reveal that pricing models based solely on property value overestimate the probability of term default and the resulting credit risk premium. Adding a property income default trigger without considering balloon risk, however, underestimates the overall credit risk premium. In essence, a double-trigger default model that incorporates balloon risk is critical for accurate assessment of the credit risk in commercial mortgages.

Comments

Accepted version. Journal of Fixed Income, Vol. 13, No. 3 (December 2003): 42-52. DOI. © Institutional Investor, Inc. 2003. Used with permission.

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