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Primary Article

Term Default, Balloon Risk, and Credit Risk in Commercial Mortgages

Charles C. Tu and mark J. Eppli
The Journal of Fixed Income Winter 2003, 13 (3) 42-52; DOI: https://doi.org/10.3905/jfi.2003.319359
Charles C. Tu
An associate professor of finance at California State University, in Fullerton, CA.
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  • For correspondence: ctu@fullerton.edu
mark J. Eppli
The Robert Bernard Bell, Sr., professor of real estate at Marquette University, in Milwaukee, WI.
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  • For correspondence: mark.eppli@mu.edu
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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.

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The Journal of Fixed Income
Vol. 13, Issue 3
Winter 2003
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Term Default, Balloon Risk, and Credit Risk in Commercial Mortgages
Charles C. Tu, mark J. Eppli
The Journal of Fixed Income Dec 2003, 13 (3) 42-52; DOI: 10.3905/jfi.2003.319359

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Term Default, Balloon Risk, and Credit Risk in Commercial Mortgages
Charles C. Tu, mark J. Eppli
The Journal of Fixed Income Dec 2003, 13 (3) 42-52; DOI: 10.3905/jfi.2003.319359
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