Option-Based Prediction of Commercial Mortgage Defaults

Leon G. Shilton () and John Teall
Additional contact information
Leon G. Shilton: Graduate School of Business Administration Fordham University Lincoln Center New York, New York 10023, http://www.bnet.fordham.edu/public/default.htm
John Teall: Department of Finance Pace University New York, New York 10038, http://www.pace.edu/lubin/

Journal of Real Estate Research, 1994, vol. 9, issue 2, pages 219-236

Abstract: Underwriters set loan-to-value ratios and loan contract interest rates of uninsured commercial mortgages to anticipate the likelihood of subsequent default. The results of the use of a modified Black-Scholes option model suggest that loan-to-value ratios are bound from below by borrowers' desires to maximize project leverage in a limited liability setting and constrained from above by lenders' requirement to originate loans with institutional-grade (Baa) contract interest rates. Given the prevailing risk-free rate and the investment-grade rate, this model at the time of mortgage origination predicts the possibility of default for a new commercial mortgage. The model is empirically verified with ACLI data for 1968-89.

JEL-codes: L85 (search for similar items in EconPapers)
Date: 1994
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