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Commercial Mortgage‐Backed Security Pricing with Real Estate Liquidity Risk
Author(s) -
Chen Peimin,
Kozhanov Igor,
Liu Peng,
Wu Chunchi
Publication year - 2021
Publication title -
real estate economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.064
H-Index - 61
eISSN - 1540-6229
pISSN - 1080-8620
DOI - 10.1111/1540-6229.12297
Subject(s) - market liquidity , economics , real estate , default risk , volatility (finance) , valuation (finance) , monetary economics , liquidity risk , commercial mortgage backed security , financial economics , econometrics , cash flow , credit risk , capitalization rate , real estate investment trust , actuarial science , finance
We propose a structural model with liquidity frictions at the property level for the pricing of commercial mortgages. The model shows that a moderate liquidity shock has a sizable effect on mortgage default risk. The sensitivities of default rates to volatility of property prices, cash payout and interest rates, all increase significantly as liquidity deteriorates. Empirical evidence strongly supports model predictions. The results suggest that failing to account for the effect of real estate illiquidity leads to substantial bias in estimation of default risk, the optimal subordination level and valuation of the structured products.