Which risk is primarily associated with RMBS compared to CMBS?

The primary risk associated with Residential Mortgage-Backed Securities (RMBS) as compared to Commercial Mortgage-Backed Securities (CMBS) is prepayment risk. This risk arises from the possibility that borrowers might repay their loans earlier than expected, particularly in a declining interest rate environment where homeowners might refinance to take advantage of lower rates.

In the case of RMBS, homeowners often have the option to prepay their mortgages. When prepayments occur, it can lead to unexpected cash flow patterns for investors because they may receive their principal back earlier than anticipated, affecting the overall return on their investment. This can happen particularly in environments where interest rates drop, leading to more refinancing activity among homeowners.

In contrast, CMBS deals with commercial properties where prepayment options are typically less frequent and more constrained. In commercial real estate loans, prepayment penalties and other factors may limit the ability of borrowers to refinance freely, which makes prepayment risk significantly lower compared to RMBS.

Thus, while default risk, systematic risk, and interest rate risk can influence both RMBS and CMBS, the distinctive characteristic that sets RMBS apart concerning risk is its exposure to prepayment risk.