Estimating Default Probabilities Implicit in Commercial
Mortgage Backed Securities (CMBS)
James B. Kau
Donald C. Keenan
Published online: 27 February 2008
Springer Science + Business Media, LLC 2008
Abstract 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.
“The subprime crisis has not been averted. In fact, it is still largely ahead of us.
The downgrades represent only a small fraction—about 2% of the mortgage-
backed securities rated for the year between the fourth quarters of 2005 and
2006—of what the rating agencies suggest could be a mountain of bad debt
J Real Estate Finan Econ (2009) 39:107–117
We would like to thank WOTN, LCC and Trepp, LCC for providing the data.
J. B. Kau
Department of Insurance, Legal Studies and Real Estate, University of Georgia,
Athens, GA 30602, USA
D. C. Keenan
Department of Economics, University of Georgia, Athens, GA 30602, USA
Y. Yildirim (*)
Whitman School of Management, Syracuse University, Syracuse, NY 13244, USA