An option-theoretic prepayment model for mortgages and mortgage-backed securities

Andrew Kalotay; Deane Yang; Frank J. Fabozzi

doi:10.1142/S0219024904002785

An option-theoretic prepayment model for mortgages and mortgage-backed securities

Andrew Kalotay, Deane Yang, Frank J. Fabozzi

Mathematics

Research output: Contribution to journal › Article › peer-review

Abstract

We introduce a new approach for modeling the prepayments of a mortgage pool and show how it can be used to value mortgage pools and agency mortgage-backed securities. We describe the full spectrum of refinancing behavior using a notion of refinancing efficiency. Our approach has two distinguishing features: (1) our primary focus is on understanding the market value of a mortgage, in contrast with standard models that strive (often unsuccessfully) to predict future cash flows, and (2) we use two separate yield curves, one for modeling mortgage cash flows and the other for MBS cash flows.

Original language	English (US)
Pages (from-to)	949-978
Number of pages	30
Journal	International Journal of Theoretical and Applied Finance
Volume	7
Issue number	8
DOIs	https://doi.org/10.1142/S0219024904002785
State	Published - Dec 2004

Keywords

Contingent claim
Mortgage
Mortgage-backed security
Option
Prepayment model
Refinancing

ASJC Scopus subject areas

General Economics, Econometrics and Finance
Finance

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10.1142/S0219024904002785

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abstract = "We introduce a new approach for modeling the prepayments of a mortgage pool and show how it can be used to value mortgage pools and agency mortgage-backed securities. We describe the full spectrum of refinancing behavior using a notion of refinancing efficiency. Our approach has two distinguishing features: (1) our primary focus is on understanding the market value of a mortgage, in contrast with standard models that strive (often unsuccessfully) to predict future cash flows, and (2) we use two separate yield curves, one for modeling mortgage cash flows and the other for MBS cash flows.",

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AB - We introduce a new approach for modeling the prepayments of a mortgage pool and show how it can be used to value mortgage pools and agency mortgage-backed securities. We describe the full spectrum of refinancing behavior using a notion of refinancing efficiency. Our approach has two distinguishing features: (1) our primary focus is on understanding the market value of a mortgage, in contrast with standard models that strive (often unsuccessfully) to predict future cash flows, and (2) we use two separate yield curves, one for modeling mortgage cash flows and the other for MBS cash flows.

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KW - Mortgage-backed security

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KW - Prepayment model

KW - Refinancing

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An option-theoretic prepayment model for mortgages and mortgage-backed securities

Abstract

Keywords

ASJC Scopus subject areas

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