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

Here is the problem with vintage per the triangular matrix method. (I gave it that term because nobody else I talked to knew what it was named.) If you look at the Esaki-Snyder report or the Wachovia CMBS 2008 Loss Study, there is this averaging method, that looks like a triangular matrix, to determine the average over vintages by loan age.

It gives one an incorrect shape of loss or defaults over the life of an asset. There is a simple test to prove this. Assume that all defaults (or losses) are constant over the life of the loan say 2% every year. The age-default profile should be a horizontal line. Now say that as the economy improves the defaults decrease by 0.2% per vintage, ie yr 2000=2%, yr 2001 = 1.8%, yr 2002 =1.6%, … but remains constant per vintage through the life of the asset.

You can do the same with increasing rates.

The method is biased because the averaged defaults (or loss) is no longer a horizontal line (the original correct input), and tends towards the value of the oldest vintage.

To make it easier for the reader I have provided the link to the Triangular Matrix Method Test Excel 2003 Spreadsheet. (Note: you may have some problems with IE8, try saving to disc.)


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