The Performance of Option-Based Default Risk Models on Commercial Mortgages

Abstract

This article applies the first-passage-time approach to estimating default probabilities of commercial mortgages and empirically tests the cash flow proposition of Vandell (1995) by Receiver Operating Characteristic (ROC) technique. The focus is on comparing default predicting performance between a single trigger model and a double-trigger model. Using 17,616 lockout commercial loans issued between 1995 and 2001, we find the property value model performs the best. For mortgage underwriters, this empirical evidence suggests that while dealing with low-quality loans, liquidity risk measured by debt coverage ratio, rather than loan-to-value ratio, should be the key factor affecting borrowers' default decisions.

TOPICS: CMBS and commercial mortgage loans, credit risk management, analysis of individual factors/risk premia