Pricing commercial mortgage‐backed securities

Clark L. Maxam, Jeffrey Fisher
2001 Journal of Property Investment & Finance  
This paper presents the first known non-proprietary empirical examination of the relationship between Commercial Mortgage Backed Security (CMBS) pricing. CMBS prices are examined as a function of the"moneyness" of the default option, the age of the security, the interest rate, interest rate volatility, property price volatility, amortization features and yield curve slope utilizing a proprietary data set of monthly prices on 40 CMBS securities. We find that though the senior tranche CMBS in the
more » ... sample are effectively immune from default loss per se, they are not immune from early return of principal and resulting duration shift implied by increasing default probabilities. Thus, they behave very much like residential mortgage backed securities in that discount security prices are positively related to explanatory variables associated with potential shifts in duration. As a result, senior tranche CMBS prices increase with explanatoryd factors that raise the likelihood of default such as property volatility and loan to value ratio whereas CMBS prices decrease with variables that lower default probability such as amortization. These empirical results fit well with existing theoretical models of multi-tranche CMBS pricing and models of commercial mortgage default and suggest that senior tranche CMBS may embody elements of risk that justify their seemingly rich spreads to similar duration corporate securities. T h e res ea rc h re g ister fo r th is jo u rn a l is a v a ila b le a t http://www.mcbup.com /research_registers T h e c u rre n t is su e a n d fu ll te x t a rc h iv e o f th is jo u rn a l is a v a ila b le a t http://www.emerald-library.com/ft Academic papers: Pricing CMBS 499 several theorized explanatory variables using linear regression techniques. In this manner, the efficacy and intuition of both empirical and theoretical models of CMBS pricing is evaluated. An observable empirical fact is that identical duration, identically rated CMBS trade at a yield premium to their corporate counterparts. Market participants typically attribute this to a liquidity premium. However, we find that though the senior tranche CMBS in the sample are effectively immune from default loss per se, they are not immune from early return of principal and the resulting duration shift implied by increasing default probabilities. Thus, they behave very much like residential mortgage backed securities in that discount security prices are positively related to explanatory variables associated with potential shifts in duration. As a result, senior tranche CMBS prices increase with explanatory factors that raise the likelihood of default such as property volatility and loan to value ratio whereas CMBS prices decrease with variables that lower default probability such as amortization. These empirical results fit well with existing theoretical models of multi-tranche CMBS pricing and models of commercial mortgage default and suggest that senior tranche CMBS may embody heretofore unrecognized risks that justify their seemingly rich spreads to similar duration, similar rated corporate securities.
doi:10.1108/14635780110406860 fatcat:32u74x7ou5fffd2nfx23ctkd74