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This series of blogs is derived form my discussions on the LinkedIn Quant Finance: What is the best approach to handling CMBS &/or RMBS Credit Risk analysis? discussion forum.

I’ve been building VaR and CVaR models for commercial property debt portfolios / deals this last 5 years.

I use a 2-layered model. The first layer (input) consists of a forecasting model based on historical data to project future losses, the second (output) layer is a Monte Carlo model.

This is my take on CMBS Loss/Credit Risk having looked at 220,000 CMBS assets (almost all the US commercial property assets since the early 1990s) for a previous employer. I can say this from experience:
1. VaR does both, it underestimates and overestimates losses.It especially underestimates losses in the 1st 2-3 years of a commercial property (bond)deal.
2. CVaR consistently gives stable estimates.
3. Much of the VaR variations are due to sampling plan and amount/quality of data you have.
4. The quality of the forecasting model is ever so critical.
5. I can say that as a general rule if you have to use tools like ARCH & GARCH you have factors missing in your data sample. But then again you may not have a choice if the data is not collected.

I have included Nassim Nicholas Taleb’s Black Swan to my set of metrics (I’ve handled this in a proprietary manner so I can’t discuss this just yet). And can tell you that there are good CMBS portfolios (Black Swan <= 20%) and some really bad ones. By bad I mean 80% wipe out.

Some other observations,
1. Residential mortgage losses are Lognormal but the catch is that much of this data is incomplete. And this problem is quite severe.
2. Commercial property losses are Gamma distributions and the incomplete data problem is not as severe.
3. I haven’t found any Normal distributions in real loss data.

My opinion to another discussion thread Is VaR a good and reliable method to measure Market Risk? would be a resounding ‘NO’ and definitely not for Credit Risk, but the industry wants to see it so I produce it.

I figure RMBS is similar but stopped working on RMBS when I realized that incomplete data was a severe problem.

I would be interested in other people’s experience in this area. I know that the DSCR based loss model is quite popular. Are there any other types of models in general use for credit risk?


Discalimer: This blog is purely for informational/educational purposes and is not intended to either negate or advocate any product, service, political position or persons.

Creative Commons License
QuantumRisk Blog Posts by Benjamin T Solomon is licensed under a Creative Commons Attribution-Noncommercial 3.0 United States License.
Based on a work at

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