Document Type

Article

Publication Date

9-2005

Source Publication

Journal of Portfolio Management

Source ISSN

0095-4918

Abstract

Much of the literature on the pricing of commercial mortgages underlying commercial mortgage-backed securities pools focuses on the effect of term default (default during the term of the loan), and ignores the possibility of balloon risk, the borrower's inability to pay off the mortgage at maturity through refinancing or property sale. A contingent-claims mortgage pricing model that includes two default triggers—a cash flow trigger and an asset value trigger—may be used to assess the effect of balloon risk on the pricing of CMBS tranches. Simulations of cash flows for individual loans in a CMBS framework reveal how individual tranches are affected by balloon risk. Balloon risk is low at the whole-loan level, but under a number of scenarios total credit risk and balloon risk creep into investment-grade CMBS tranches and significantly impact their valuation.

Comments

Accepted version. Journal of Portfolio Management, Vol. 31, No. 5 (September 2005): 114-123. DOI. © Institutional Investor, Inc. 2005. Used with permission.