How Much Subordination is Enough?
) (Jones Graduate School of Management Rice University) Abstract The commercial mortgage-backed security market has experienced rapid growth in recent years, and is now the second most important source of intermediation to the commercial real estate sector. Despite its growing importance, relatively little academic research has questioned the apparent success of the CMBS capital structure. In this paper, we study whether the recent growth in the CMBS market actually reflects the mitigation of a market imperfection, as some have suggested, or reflects ever thinner subordination levels, perhaps backed up by overly aggressive assumptions about future commercial real estate performance. Our analysis is based on a multi-factor structural model of commercial mortage defaults in which defaults are a function of interest rates and property prices. The model incorporates heterogeneity at the borrower level and transaction frictions, rendering solution of the model highly computationally burdens
