Journal of Real Estate Finance and Economics, 27:1, 5±23, 2003
# 2003 Kluwer Academic Publishers. Manufactured in The Netherlands.
A Proportional Hazards Model of Commercial
Mortgage Default with Originator Bias
BRIAN A. CIOCHETTI
Department of Finance, University of North Carolina, Chapel Hill, NC, U.S.A.
School of Policy, Planning andDevelopment, University of Southern California, Los Angeles, CA, U.S.A.
Credit Suisse First Boston, New York, NY, U.S.A.
JAMES D. SHILLING
University of Wisconsin, Madison, WI, U.S.A.
Department of Economics andFinance, Baruch College, New York, NY, U.S.A.
A proportional hazards model with competing risks is speci®ed and is extended to correct for the possibility of
originator bias. The model is used to examine the ability of option-theoretic models of mortgage pricing to
forecast commercial mortgage defaults. Among the ®ndings, those especially of interest include the in¯uence of
contemporaneous loan-to-value and debt-service-coverage ratios on commercial mortgage default probabilities.
The paper also ®nds that option-theoretic models of mortgage pricing are quite capable of producing default
estimates that ®t the actual default rates well, especially when the model is corrected for originator bias.
Key Words: commercial mortgages, default, competing risks, hazard model, sampling bias
In this paper we ask the following question, can option-theoretic models of mortgage
pricing forecast commercial mortgage defaults? In order to test this hypothesis we set up
an econometric model of commercial mortgage defaults that is predicated on option
pricing theory. The model has several antecedents in the literature (see, for example,
Ciochetti et al., 2002; Deng et al., 2002; Han and Hausman, 1990; and Suyoshi, 1992).
The model offers an opportunity to determine if option pricing theory can foretell
commercial mortgage defaults over a period in which commercial mortgage default rates