RT Journal Article
SR Electronic
T1 CMBS Tranche Valuation Framework: Correlated
Geometric Brownian Motions Simulation
JF The Journal of Fixed Income
FD Institutional Investor Journals
SP 55
OP 66
DO 10.3905/jfi.2011.21.1.055
VO 21
IS 1
A1 Peijie Shiu
A1 Uyen Luong
A1 Yadin Rozov
YR 2011
UL https://pm-research.com/content/21/1/55.abstract
AB This article proposes a Monte Carlo simulation framework for valuation of commercial mortgage-backed securities (CMBS) based on loan level net operating income (NOI) and market capitalization rate. By using geometric Brownian motions (GBM) to create stochastic paths for NOI and cap rate, one can simulate credit defaults and loss severity. Correlation is introduced between loan NOIs to allocate losses along the capital structure of the CMBS. Stochastic months-to-recovery variables are also generated through a Poisson process to capture equity tranche interest-only option value. The model offers a framework to systematically evaluate CMBS tranche prices by decomposing principal prepayment risk as well as credit default risk, which offers potential trading opportunities in the market.TOPICS: CMBS and commercial mortgage loans, simulations, credit risk management