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The Termination of Commercial Mortgage Contracts through Prepayment and Default: A Proportional Hazard Approach with Competing Risks
Author(s) -
Ciochetti Brian A.,
Deng Yongheng,
Gao Bin,
Yao Rui
Publication year - 2002
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.t01-1-00053
Subject(s) - prepayment of loan , mortgage underwriting , default , cash flow , default risk , actuarial science , economics , loan , proxy (statistics) , moral hazard , credit risk , econometrics , mortgage insurance , finance , microeconomics , computer science , insurance policy , incentive , casualty insurance , machine learning
This article examines the factors driving the borrower’s decision to terminate commercial mortgage contracts with the lender through either prepayment or default. Using loan–level data, we estimate prepayment and default functions in a proportional hazard framework with competing risks, allowing us to account for unobserved heterogeneity. Under a strict definition of mortgage default, we do not find evidence to support the existence of unobserved heterogeneity. However, when the definition of mortgage default is relaxed, we do find some evidence of two distinctive borrower groups. Our results suggest that the values of implicit put and call options drive default and prepayment actions in a nonlinear and interactive fashion. Prepayment and default risks are found to be convex in the intrinsic value of call and put options, respectively. Consistent with the joint nature of the two underlying options, high value of the put/call option is found to significantly reduce the call/put risk since the borrower forfeits both options by exercising one. Variables that proxy for cash flow and credit conditions as well as ex post bargaining powers are also found to have significant influence upon the borrower’s mortgage termination decision.