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| Option-Based Prediction of Commercial
Mortgage Defaults Author: Leon G. Shilton and John Teall Start Page: 219 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. |
