Commercial Mortgage‐Backed Security Pricing with Real Estate Liquidity Risk

Abstract

We propose a structural model with liquidity frictions at the property level for the pricing of commercial mortgages. The model shows that a moderate liquidity shock has a sizable effect on mortgage default risk. The sensitivities of default rates to volatility of property prices, cash payout and interest rates, all increase significantly as liquidity deteriorates. Empirical evidence strongly supports model predictions. The results suggest that failing to account for the effect of real estate illiquidity leads to substantial bias in estimation of default risk, the optimal subordination level and valuation of the structured products.

Property market liquidity and REIT liquidity

“…(2007) and Chen et al. (2021) show that asset values are affected by market liquidity. In particular, illiquidity generally leads to price discounts in equilibrium.…”

“…On the one hand, firms with higher exposure to more liquid and less opaque asset markets tend to experience less valuation uncertainty. Duffie et al (2007) and Chen et al (2021) show that asset values are affected by market liquidity. In particular, illiquidity generally leads to price discounts in equilibrium.…”

Optimization of profitability and liquidity for residential projects under debt and equity financing

“…Then, a MANOVA is conducted to analyze the effect of independent variables FR (Zayed and Liu, 2014;Chen et al, 2019), P (Wei and Yun, 2015;Geltner and Mei, 1995;Chen et al, 2019) and SRT (Purnus and Bodea, 2015;Susilawati, 1998) on the dependent variables (NPV and payback period). Since MANOVA is a quantitative fixed-effects statistical model, it is performed on scenarios with predetermined factor level configurations and their related NPV and payback period results at a significance level of 5%.…”

“…Therefore, the net present value (NPV), the difference between the present worth of cash inflows and outflows, is frequently addressed in project cash flow management to analyze the profitability of a project or an investment (Aziz, 2013;Geltner and Mei, 1995). In financial markets, liquidity is defined as the ability to sell and buy assets quickly at the intrinsic value without causing a drastic change in the asset's price (Chen et al, 2019). Liquidity is a relative concept for direct real estate investments due to high-transaction costs, lengthy and uncertain trading times and low frequency of transactions (Ametefe et al, 2019).…”