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

Andrew Kalotay, Deane Yang, Frank J. Fabozzi

Research output: Contribution to journalArticle

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 languageEnglish (US)
Pages (from-to)949-978
Number of pages30
JournalInternational Journal of Theoretical and Applied Finance
Volume7
Issue number8
DOIs
StatePublished - Dec 2004

Keywords

  • Contingent claim
  • Mortgage
  • Mortgage-backed security
  • Option
  • Prepayment model
  • Refinancing

ASJC Scopus subject areas

  • Finance
  • Economics, Econometrics and Finance(all)

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