Strategic default,workout, and commercial mortgage valuation |
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Authors: | Timothy J Riddiough Steve B Wyatt |
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Institution: | (1) Department of Urban Studies and Planning, Center for Real Estate, Massachusetts Institute of Technology, 02139-4307 Cambridge, MA;(2) Department of Finance, College of Business Administration, University of Cincinnati, 45221-0195 Cincinnati, OH |
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Abstract: | This paper extends existing equilibrium commercial mortgage pricing models by endogenizing negotiated workout into the usual noncooperative lending game. Workout is a feasible subgame strategy for the lender to play whenever foreclosure transaction costs exist for either party to a loan transaction. In particular, negotiated workout solutions Pareto dominate the foreclosure alternative when default occurs. To obtain our results, we embed a cooperative bargaining game within a noncooperative mortgage loan/default game. We also address the valuation wedge problem that occurs when foreclosure transaction costs are introduced. Through the notion of replacement game equilibrium, we find symmetric mortgage pricing solutions that eliminate the valuation wedge and thus suggest that lending will occur in commercial real estate mortgage markets even when foreclosure transaction costs exist. |
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Keywords: | Mortgage pricing bargaining workout replacement game |
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