Abstract
I study the time series dynamics of commercial mortgage credit risk and the unobservable systematic risk factors underlying those dynamics. A first-passage model with equilibrium macroeconomic dynamics is presented, and the default hazard rate is solved. The solutions are then put into a state space form and estimated with real world commercial mortgage performance data using extended Kalman filter. Results show large variations of credit risk over time in the commercial mortgage market, and that these variations are well explained by two mean-reverting latent risk factors. One is the macroeconomic factor and the other is a commercial property market-specific factor. The model and the results will be useful in default risk prediction, hedging and pricing.
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