Credit Risk and the Term Structure of Lease Rates: A Reduced Form Approach

26 Pages Posted: 1 Oct 2008 Last revised: 3 Feb 2011

See all articles by Brent W. Ambrose

Brent W. Ambrose

Pennsylvania State University

Yildiray Yildirim

Zicklin School of Business, Baruch College - The City University of New York

Date Written: September 30, 2008

Abstract

Previous research either assumes default free leases or leases subject to default risk using a structural approach. However, structural credit risk models suffer from a common criticism that the firm's asset value process is unobservable. We develop a reduced form credit risk model for leases that avoids making assumptions regarding unobservable asset valuation processes. Furthermore, we assume a correlated market and credit risk that provides us with a simple analytic formula for valuing defaultable lease contracts. Numerical analysis reveals that tenant credit risk can have a substantial impact on the term structure of leases. Finally, we use the model to demonstrate the implied lease term structure for a set of retail and financial firms in the Fall of 2000.

Keywords: leasing valuation, credit risk, reduced form model

JEL Classification: G33, G12

Suggested Citation

Ambrose, Brent W. and Yildirim, Yildiray, Credit Risk and the Term Structure of Lease Rates: A Reduced Form Approach (September 30, 2008). Journal of Real Estate Finance and Economics, Vol. 37, No. 3, 2008. Available at SSRN: https://ssrn.com/abstract=1275921

Brent W. Ambrose (Contact Author)

Pennsylvania State University ( email )

University Park, PA 16802-3306
United States
814-867-0066 (Phone)
814-865-6284 (Fax)

Yildiray Yildirim

Zicklin School of Business, Baruch College - The City University of New York ( email )

55 Lexington Ave., Box B13-260
New York, NY 10010
United States

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