Estimating Default Probabilities Implicit in Commercial Mortgage Backed Securities (CMBS)

This paper uses a structural credit risk model, providing an analytical formula to estimate default probabilities implicit in commercial mortgage backed security prices. Empirical studies of CMBS default have focused on the probability of default depending on loan characteristics at the origination and market indices. Recent studies show that unobservable current loan-to-value (LTV) ratio is a key state variable driving default. We update this variable using Real Estate Investment Trust (REIT) property-type indices over time. Later, we employ first passage time approach to study CMBS default using implied LTV.

Credit Risk and the Term Structure of Lease Rates: A Reduced Form Approach

Previous research either assumes default free leases or leases subject to default risk using a structural approach. However, structural credit risk models suffer from a common criticism that the firm’s asset value process is unobservable. We develop a reduced form credit risk model for leases that avoids making assumptions regarding unobservable asset valuation processes. Furthermore, we assume a correlated market and credit risk that provides us with a simple analytic formula for valuing defaultable lease contracts. Numerical analysis reveals that tenant credit risk can have a substantial impact on the term structure of leases. Finally, we use the model to demonstrate the implied lease term structure for a set of retail and financial firms in the Fall of 2000.

Enterprise risk management in financial groups: analysis of risk concentration and default risk

In financial groups, enterprise risk management is becoming increasingly important in controlling and managing the different independent legal entities in the group. The aim of this paper is to assess and relate risk concentration and joint default probabilities of the group’s legal entities in order to achieve a more comprehensive picture of a financial group’s risk situation. We further examine the impact of the type of dependence structure on results by comparing linear and nonlinear dependencies using different copula concepts under certain distributional assumptions. Our results show that even if financial groups with different dependence structures do have the same risk concentration factor, joint default probabilities of different sets of subsidiaries can vary tremendously.

The Value of Equitable Redemption in Commercial Mortgage Contracting

Equitable redemption is a feature of all common law mortgages that allows a borrower a chance to “redeem” the real estate in the event of default. What is puzzling is that equitable redemption is universally enforced in all mortgages, including commercial mortgages. The purpose of this study is to understand if there might be conditions under which the universal enforcement of equitable redemption could be an efficient legal doctrine. We build a model of asymmetric information where the cash flows from the investment are known to the borrower but not to the lender. We show that there exists a separating equilibrium where high-risk borrowers choose to include equitable redemption (and pay a higher interest rate) while low-risk borrowers choose not to (and pay a lower interest rate). We then show that there exist conditions under which a universal enforcement of equitable redemption results in a higher total surplus than this separating equilibrium.

Selecting credit rating models: a cross-validation-based comparison of discriminatory power

In commercial banking, various statistical models for corporate credit rating have been theoretically promoted and applied to bank-specific credit portfolios. In this paper, we empirically compare and test the performance of a wide range of parametric and nonparametric credit rating model approaches in a statistically coherent way, based on a ‘real-world’ data set. We repetitively (k times) split a large sample of industrial firms’ default data into disjoint training and validation subsamples. For all model types, we estimate k out-of-sample discriminatory power measures, allowing us to compare the models coherently. We observe that more complex and nonparametric approaches, such as random forest, neural networks, and generalized additive models, perform best in-sample. However, comparing k out-of-sample cross-validation results, these models overfit and lose some of their predictive power. Rather than improving discriminatory power, we perceive their major contribution to be their usefulness as diagnostic tools for the selection of rating factors and the development of simpler, parametric models.

Delinquency and Default in Arms: The Effects of Protected Equity and Loss Aversion

This paper extends the extant literature in understanding the effects of equity and debt on delinquency and default by focusing on a variant of borrower equity where part of equity is “protected”. The CPF scheme in Singapore stipulates that the refund of borrower’s retirement funds utilized for property purchase prior to September 2002 takes priority over loan obligations. A decision to utilize CPF for property purchase actually increases ex post delinquency and default risk as it effectively reduces cash equity commitment. In particular, any erosion in house value that places protected equity at risk translates into potential wealth reduction or financial liability for the borrower. While loss aversion is evident for non-distressed sellers, the effect of equity losses for distressed borrowers is not as clear. Our research suggests that averting losses in committed equity may be a secondary consideration for borrower subject to income shocks, recognizing that delinquency and default are precursors to foreclosure. Interestingly, we find that the borrowers are strongly averse to incurring protected equity-induced wealth loss or financial liability. This study suggests that the first-lien “anomaly” associated with CPF refund may reduce delinquency and default risks for mortgage backed securities.

Credit default swap prices as risk indicators of listed German banks

This paper explores empirically the usefulness of credit default swap (CDS) prices as market indicators. The sample of reference entities consists of large, internationally active German banks and the observation period covers 3 years. By analysing the explanatory power of three risk sources: idiosyncratic credit risk, systematic credit risk and liquidity risk, we gain important insights into modeling the dynamics of CDS spreads. The impact of systematic risk, for example, has three components; one is related to the overall state of the economy, another related to the risk of the internationally active banking sector, and the third is an unobservable systematic factor. Default probabilities, inferred from a tractable reduced form model for CDS spreads, are compared with expected default frequencies from the Moody’s KMV model. The results lend empirical support to the hypothesis that structural models can be less informative than reduced-form models of CDS spreads in the case of banks with major investment banking activities as the leverage loses explanatory power. Although the CDS market appears to have matured over the observation period, during certain periods premiums for liquidity risk can increase substantially thus limiting the value of CDS spreads as market indicators. We conclude that equity prices and CDS premia should be considered together to fully exploit the information content of both market indicators and to mitigate their respective drawbacks.

The Structure of Chinese Urban Land Prices: Estimates from Benchmark Land Price Data

Taking the recent benchmark land prices published by the Chinese city governments, the paper estimates commercial and residential land price curves of Chinese cities using cross-sectional data, controlling for urban population size and income level. The urban land leasing price–distance relationship is estimated based on the argument that monocentric urban structure is representative for Chinese cities. Both population size and income level are found to positively affect urban land price and price–distance gradients. Commercial land prices are higher than residential land prices except in suburbs or outer central urban areas, where the land prices of different uses converge. In most situations, commercial use price gradients are larger than those of residential use.

Can Space Syntax Help Us in Understanding the Intraurban Office Rent Pattern? Accessibility and Rents in Downtown Stockholm

The effect of accessibility upon rent is investigated for office properties located in Downtown Stockholm. Starting from the firm’s cost minimization problem, a translog hedonic model is derived. The results suggest the model has good predictive power in explaining the variation in the log of the rent. A negative rent gradient is obtained with a base approximately 90 m from the postulated focal point. It appears as if Space Syntax adds important information to the understanding of the intraurban office rent pattern.

The Sensitivity of the Loss Given Default Rate to Systematic Risk: New Empirical Evidence on Bank Loans

We verify the existence of a relation between loss given default rate (LGDR) and macroeconomic conditions by examining 11,649 bank loans concerning the Italian market. Using both the univariate and multivariate analyses, we pinpoint diverse macroeconomic explanatory variables for LGDR on loans to households and SMEs. For households, LGDR is more sensitive to the default-to-loan ratio, the unemployment rate, and household consumption. For SMEs, LGDR is influenced by the total number of employed people and the GDP growth rate. These findings corroborate the Basel Committee’s provision that LGDR quantification process must identify distinct downturn conditions for each supervisory asset class.

Performance measurement manipulation: cherry-picking what to correct

A common feature of managerial and financial reporting is an iterative process wherein various parties selectively correct particular measurements by challenging them and subjecting them to increased scrutiny. We model this feature by adding an agent appeal stage to the standard moral hazard model and show that it can be optimal to allow the agent to decide which performance measures to appeal, despite the agent’s incentive to cherry-pick. In the presence of measurement errors, the agent is incentivized by increased opportunities for cherry-picking that arise if he chooses the “right” vs. the “wrong” acts.

Valuing corporate securities: some effects of bond indenture provisions—a correction

This paper identifies and corrects a typographical error in Black and Cox (J Finance 31:351–367, 1976). While the typographical error is seemingly trivial, the magnitude of the pricing error that it generates can be substantial.

Do Internet Activities Add Value? Evidence from the Traditional Banks

Very little is known about how adopting Internet activities impact traditional banks. By tracing the experience of Italian commercial banks, we provide evidence and implications for banks’ use of new Internet technology and innovative banking products as they relate to performance. Using different definitions for what is considered as Internet activity and by examining alternative proxies for bank return and risk, we find a significant link between offerings of Internet banking products and bank performance. Although this link is significantly positive for bank returns, we find a negative, marginally significant, association between the adoption of Internet activities and bank risk.

The contextual nature of the predictive power of statistically-based quarterly earnings models

We present new empirical evidence on the contextual nature of the predictive power of five statistically-based quarterly earnings expectation models evaluated on a holdout period spanning the twelve quarters from 2000–2002. In marked contrast to extant time-series work, the random walk with drift (RWD) model provides significantly more accurate pooled, one-step-ahead quarterly earnings predictions for a sample of high-technology firms (n = 202). In similar predictive comparisons, the Griffin-Watts (GW) ARIMA model provides significantly more accurate quarterly earnings predictions for a sample of regulated firms (n = 218). Finally, the RWD and GW ARIMA models jointly dominate the other expectation models (i.e., seasonal random walk with drift, the Brown-Rozeff (BR) and Foster (F) ARIMA models) for a default sample of firms (n = 796). We provide supplementary analyses that document the: (1) increased frequency of the number of loss quarters experienced by our sample firms in the holdout period (2000–2002) vis-à-vis the identification period (1990–1999); (2) reduced levels of earnings persistence for our sample firms relative to earnings persistence factors computed by Baginski et al. (2003) during earlier time periods (1970s–1980s); (3) relative impact on the predictive ability of the five expectation models conditioned upon the extent of analyst coverage of sample firms (i.e., no coverage, moderate coverage, and extensive coverage); and (4) sensitivity of predictive performance across subsets of regulated firms with the BR ARIMA model providing the most accurate predictions for utilities (n = 87) while the RWD model is superior for financial institutions (n = 131).

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The Reaction by Industry Insiders to M&;As in the European Financial Industry

This paper looks at the reaction by industry insiders, industry analysts and competing firms, to the announcement of M&As that took place in the European Union financial industry in the period 1998–2006. Analysts covering firms involved in an M&A transaction do not significantly alter their recommendation. This is consistent with the hypothesis that the transaction on average is “fairly priced” and that stock market prices reflect all relevant information on the assets. We also find that the correlation between excess returns for merging and competing firms is positive and, in some cases, significantly higher for domestic mergers than for international deals. This is consistent with the idea that domestic deals are more likely to have a negative impact on industry competition.

Correlation and Volatility Dynamics in International Real Estate Securities Markets

We study international correlation and volatility dynamics of publicly traded real estate securities using monthly returns from 1984 and 2006. We also examine, for comparison, the correlations among the corresponding stock markets. A multivariate dynamic conditional correlation model captures the time-varying correlation within the full period. We confirm lower correlations between all real estate securities market returns than those between the stock market returns themselves. Some significant variations and structural changes in the correlation structure happened within the sample period. We detect a strong and positive connection between real estate securities market correlations and their conditional volatilities. We also find the international correlation structure of real estate securities and the broader stock market are linked to each other. Our results have economic motivations regarding the potential integration of international real estate securities markets and the possibility of including information on changing correlations and volatilities to design more optimal portfolios for international real estate securities.

Heterogeneous time varying transaction costs and asset pricing in international equity markets

In this paper, we examine the time variation in transaction costs relative to excess returns, in a panel consisting of 10 international equity indices over the time period 1984–2005. This is undertaken by extending the consumption CAPM (CCAPM) model proposed by Campbell and Shiller (Rev. Financ. Stud. 1:195–228, 1988) to incorporate time varying proportional transaction costs. We rigorously address both the cross-country heterogeneity in the estimated model and endogeneity. We find strong evidence that suggests transaction costs should be included as an additional explanatory variable in the CCAPM. This leads to the conclusion that transaction costs should be included in asset pricing models as their stochastic process impacts directly on private consumption expenditure.

Residual income,value-relevant information and equity valuation: a simultaneous equations approach

The paper uses Ohlson (Contemp Account Res 11:661–687, 1995) and compares the relative predictability of the proposed simultaneous model for contemporaneous stock price with a traditional single equation model used by the previous studies. The paper also explores how residual income and value-relevant information affect firms’ equity price. The main results of the paper suggest that the predictive ability and estimation efficiency of the simultaneous models in explaining contemporaneous stock prices are better than those of the traditional single models. Moreover, investors will use the value-relevant information beyond accounting earnings, namely analysts’ earnings forecasts, bankruptcy cost and agency cost, in equity valuation to make decision. Note particularly, the higher the bankruptcy or agency cost is, the more important the role it plays in equity valuation and, on average, the higher the accuracy of price prediction is.

Asset Price Spillover,Collateral and Crises: with an Application to Property Market Policy

This paper studies the impact of land supply elasticity and land use regulation. For sufficiently adverse shocks constrained entrepreneurs liquidate their assets for debt repayment. This effect can spillover to the residential property market. A crisis occurs when households are forced to default on their mortgages as well. While both converting costs and land use regulation tend to magnify the effect of adverse shock, the former generates an asymmetric effect between a positive and a negative shock on the land market, and the latter tends to raise the likelihood of a crisis, by raising the threshold value of liquidation.

Home Equity,Household Savings and Consumption

The home-owning family’s equity is a piggybank that can be broken open by borrowing. Each borrowing increases liabilities and cash equally, initially leaving net wealth unchanged. When those funds are spent and cash balances fall, consumption increases even as net wealth can decline. In a dynamic optimization, the marginal propensity to consume from net wealth is not always positive and can be positively correlated with housing debt.