Commercial Mortgage Delinquency, Foreclosure and Reinstatement

An early paper about the empirical testing of multiple factor asset-pricing models isChen, Roll and Ross (1986). Motivated by the Arbitrage Pricing Theory of Ross (1976), theyidentify a set of macroeconomic factors and create a model to describe stock market returns. Thefive factors that are identified and tested are the term spread between long and short interest rates,the default spread between high and low risk bonds, growth in industrial production, change inexpected inflation and unexpected inflation. In addition, Chen, Roll and Ross use a valueweightedstock market index.Fama and French (1993) (FF) differ from Chen, Roll and Ross in two ways relevant tomy work. First, they expand the set of asset returns to include corporate and government bonds,which I will expand further to include commercial mortgages and real estate. Second, theyemploy a time-series regression approach that originated with Black, Jensen and Scholes (1972).The equation being estimated isitftiK∑r − r = α + β F + e(1)k =1ikktitwhere F kt are various macroeconomic factors at time t and the dependent variable is anexcess return (r it is the return for asset i at time t and r ft is the risk-free rate of return at time t).FF designated three factors as stock market-related: an overall market factor, a factorrelated to firm size and a factor related to the ratio of book equity to market equity 6 . Two factorswere designated bond market factors: the term spread and the default spread.Several papers have used the multiple factor model framework to examine real estatereturns (although none have yet considered commercial mortgage returns). Chan, Hendershottand Sanders (1990) analyze real estate returns using the method and factors from by Chen, Rolland Ross. A difficulty in analyzing real estate is that there are two potential sources of returninformation, REIT returns and appraisal-based returns, neither which is believed to be a perfectmeasure of the true nature of real estate volatility, as discussed in Corgel and deRoos (1999) and6 See Table 1 for more detail about the factors.5