Hostname: page-component-76fb5796d-22dnz Total loading time: 0 Render date: 2024-04-25T19:01:43.350Z Has data issue: false hasContentIssue false
  • English
  • Français

The Pricing of Multiclass Commercial Mortgage-Backed Securities

Published online by Cambridge University Press:  09 June 2010

Paul D. Childs ,
Steven H. Ott  and
Timothy J. Riddiough
Paul D. Childs
Affiliation:
Department of Finance, College of Business and Economics, University of Kentucky, Lexington, KY 40506-0034
Steven H. Ott
Affiliation:
Department of Finance, College of Business and Economics, University of Kentucky, Lexington, KY 40506-0034
Timothy J. Riddiough
Affiliation:
Department of Urban Studies and Planning, Center for Real Estate, Massachusetts Institute of Technology, Cambridge, MA 02139-4307.
Get access Rights & Permissions [Opens in a new window]

Abstract

This paper considers the pricing of multiclass commercial mortgage-backed securities. A contingent-claims pricing methodology that overcomes state variable dimensionality problems is developed to examine mortgage pools with many distinct underlying assets and whose loan cash flow values are subject to interest rate uncertainty. Security structure and the correlation structure of collateralizing assets within a pool are found to be important determinants of tranche price and required yield spread. By disentangling default loss risk from default-related call risk, we show it is possible that mezzanine investment classes may require lower yield spreads than higher priority investment classes. Of particular interest is the finding that reduced cash flow volatility obtained through pool diversification may actually decrease the value of the first-loss (junior) tranche. When examining the relationship of pool size and tranche value, we find that five to 10 distinct mortgages are required to realize most of the effects of asset diversification.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 31 , Issue 4 , December 1996 , pp. 581 - 603
Copyright
Copyright © School of Business Administration, University of Washington 1996

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Black, F., and Cox, J. C.. “Valuing Corporate Securities: Some Effects of Bond Indenture Provisions.” Journal of Finance. 31 (May 1976), 351–367.CrossRefGoogle Scholar
Boot, A. W. A., and Thakor, A. V.. “Security Design.” Journal of Finance. 48 (Sept. 1993). 1349–1378.CrossRefGoogle Scholar
Childs, P. D.; Ott, S. H.; and Riddiough, T. J.. “The Value of Recourse and Cross-Default Causes in Commercial Mortgage Contracting.” Journal of Banking and Finance. 20 (April 1996). 511–536.CrossRefGoogle Scholar
Corcoran, P. J. “Debt and Equity in the New Real Estate Markets.” Real Estate Finance. (Fall 1995). 73–82.Google Scholar
Cox, J. C.; Ingersoll, J. E.; and Ross, S. A.. “An Intertemporal General Equilibrium Model of Asset Prices.” Econometrica. 53 (March 1985a), 363–384.CrossRefGoogle Scholar
Cox, J. C.; Ingersoll, J. E.; and Ross, S. A.. “A Theory of the Term Structure of Interest Rates.” Econometrica. 53 (March 1985b), 385–407.CrossRefGoogle Scholar
Duff & Phelps Rating Company. “The Rating of Commercial Mortgage-Backed Securities.” (Oct. 1994).Google Scholar
Dunn, K. B., and McConnell, J. J.. “Valuation of GNMA Mortgage-Backed Securities.” Journal of Finance. 36 (June 1981), 599–616.Google Scholar
Grenadier, S. R. “Valuing Lease Contracts: A Real-Options Approach.” Journal of Financial Economics. 38 (July 1995), 297–331.CrossRefGoogle Scholar
Goetzmann, W. N., and Ibbotson, R. G.. “The Performance of Real Estate as an Asset Class.” Journal of Applied Corporate Finance. 13 (Fall 1990), 65–76.CrossRefGoogle Scholar
Hartzell, D.; Hekman, J.; and Miles, M.. “Diversification Categories in Investment Real Estate.” AREUEA Journal. 14 (Summer 1986). 230–259.CrossRefGoogle Scholar
Holland, S. A.; Ott, S. H.; and Riddiough, T. J.. “Uncertainty and the Rate of Commercial Real Estate Development.” Unpubl. Manuscript, The Economics Institute (1995).Google Scholar
Hull, J., and White, A.. “Valuing Derivative Securities Using the Explicit Difference Method.” Journal of Financial and Quantitative Analysis. 25 (March 1990), 87–100.CrossRefGoogle Scholar
Hull, J., and White, A.. “Numerical Procedures for Implementing Term Structure Models II: Two-Factor Models.” Journal of Derivatives. 2 (Winter 1994), 37–48.CrossRefGoogle Scholar
Kau, J. B.; Keenan, D. C.; Muller, W. S.; and Epperson, J. F.. “Option Theory and Floating-Rate Securities with a Comparison of Adjustable and Fixed-Rate Mortgages.” Journal of Business, 66 (Oct. 1993), 595–618.CrossRefGoogle Scholar
McConnell, J. J.. and Singh, M.. “Rational Prepayments and the Valuation of Collateralized Mortgage Obligations.” Journal of Finance. 49 (July 1994). 891–921.CrossRefGoogle Scholar
Nomura Securities International, Inc.—Global Real Estate Research. “Commercial Real Estate Quarterly.” (Jan. 1996).Google Scholar
Titman, S., and Torous, W. N.. “Valuing Commercial Mortgages: An Empirical Investigation of the Contingent-Claims Approach to Pricing Risky Debt.” Journal of Finance, 44 (June 1989), 345–373.Google Scholar
Tong, Y. L.The Multivariate Normal Distribution. New York. NY: Springer-Verlag (1990).CrossRefGoogle Scholar