Extreme Events and the Copula Pricing of Commercial Mortgage-Backed Securities

32 Pages Posted: 12 Nov 2008 Last revised: 14 Nov 2013

See all articles by Zhanyong Simon Liu

Zhanyong Simon Liu

affiliation not provided to SSRN

Gang-Zhi Fan

Beijing Normal University-Hong Kong Baptist University United International College

Kian-Guan Lim

Singapore Management University - Lee Kong Chian School of Business

Date Written: April 25, 2008

Abstract

Commercial mortgage-backed securities (CMBS), as a portfolio-based financial product, have gained great popularity in financial markets. This paper extends Childs, Ott and Riddiough's (1996, JFQA) model by proposing a copula-based methodology for pricing CMBS bonds. Default on underlying commercial mortgages within a pool is a crucial risk associated with CMBS transactions. Two important issues associated with such default - extreme events and default dependencies among the mortgages - have been identified to play crucial roles in determining credit risk in the pooled commercial mortgage portfolios. This article pays particular attention to these two issues in pricing CMBS bonds. Our results show the usefulness and potential of copula-based models in pricing CMBS bonds, and the ability of such models to correctly price CMBS tranches of different seniorities. It is also important to sufficiently consider complex default dependence structure and the likelihood of extreme events occurring in pricing various CMBS bonds.

Keywords: CMBS, copula model, extreme events, heavy tail, tail dependence

Suggested Citation

Liu, Zhanyong Simon and Fan, Gang-Zhi and Lim, Kian-Guan, Extreme Events and the Copula Pricing of Commercial Mortgage-Backed Securities (April 25, 2008). Journal of Real Estate Finance and Economics, Vol. 38, No. 3, 2009, Available at SSRN: https://ssrn.com/abstract=1299215

Zhanyong Simon Liu

affiliation not provided to SSRN ( email )

Gang-Zhi Fan (Contact Author)

Beijing Normal University-Hong Kong Baptist University United International College ( email )

2000 Jintong Road
Zhuhai, Guangdong 519087
China

Kian-Guan Lim

Singapore Management University - Lee Kong Chian School of Business ( email )

50 Stamford Road #05-01
Singapore, 178899
Singapore

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