A Generalized Valuation Model for Fixed-Rate Residential Mortgages

Kau, James B.; Keenan, Donald C.; Muller, Walter J.; Epperson, James F.

doi:10.2307/1992718

Cited by 304 publications

(182 citation statements)

References 12 publications

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“…Several recent papers consider both default and prepayment. Kau, Keenan, Muller, and Epperson (1992), Kau, Keenan, Muller, and Epperson (1995), and Kau (1995), lay out a structural two-factor option-pricing model for prepayment and default. However, they perform no empirical estimation or testing of their model.…”

Section: Pricing Risky Debtmentioning

confidence: 99%

An Empirical Test of a Two-Factor Mortgage Valuation Model: How Much Do House Prices Matter?

Downing¹,

Stanton²,

Wallace³

2005

Real Estate Econ

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Mortgage-backed securities, with their relative structural simplicity and their lack of recovery rate uncertainty if default occurs, are particularly suitable for developing and testing risky debt valuation models. In this paper, we develop a two-factor structural mortgage pricing model in which rational mortgage-holders endogenously choose when to prepay and default subject to i. explicit frictions (transaction costs) payable when terminating their mortgages, ii. exogenous background terminations, and iii. a credit related impact of the loan-to-value ratio (LTV) on prepayment. We estimate the model using pool-level mortgage termination data for Freddie Mac Participation Certificates, and find that the effect of the house price factor on the results is both statistically and economically significant. Out-of-sample estimates of MBS prices produce option adjusted spreads of between 5 and 25 basis points, well within quoted values for these securities.

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Section: Pricing Risky Debtmentioning

confidence: 99%

An Empirical Test of a Two-Factor Mortgage Valuation Model: How Much Do House Prices Matter?

Downing¹,

Stanton²,

Wallace³

2005

Real Estate Econ

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“…A number of studies have applied this model to the mortgage market (see, for example, Dunn and McConnell, 1981;Buser and Hendershott, 1984;Brennan and Schwartz, 1985;Kau et al, 1992Quigley and Van Order, 1995). Hendershott and Van Order (1987) and provide surveys of these models and results.…”

Section: Introductionmentioning

confidence: 99%

Mortgage default and low downpayment loans: The costs of public subsidy

Deng

Quigley

Order

1996

Regional Science and Urban Economics

106

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This paper presents a unified model of the default and prepayment behavior of homeowners in a proportional hazard framework. The model uses the option-based approach to analyze default and prepayment, and considers these two interdependent hazards as competing risks. The results indicate the sensitivity of default to the initial loan-to-value ratio of the loan and the course of housing equity. The latter is a measure of the extent to which the default option is in the money. The results also indicate the importance of trigger events, namely unemployment and divorce, in affecting prepayment and default behavior. The empirical results are used to analyze the costs of a current policy proposal-stimulating homeownership by offering low downpayment loans. We simulate default probabilities and costs on zero-downpaymerit loans and compare them with conventional loans with conventional underwriting standards. The results indicate that if zero-downpayment loans were priced as if they were mortgages with 10% downpayments, then the additional program costs would be 2-4% of funds made available-when housing prices increase steadily. If housing prices remained constant, the costs of the program would be much larger indeed. Our estimates suggest that additional program costs could be between $74,000 and $87,000 per million dollars of lending. If the expected losses from such a program were not priced at all, the losses from default alone could exceed 10% of the funds made available for loans.

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“…Kau, Keenan, Muller, and Epperson, 1992). Parameter σ H is the real estate volatility and Z H t is the standard Brownian motion driving real estate values.…”

Section: Non-amortizing Participating Mortgages and The Dodd-frank Actmentioning

confidence: 99%

Reducing the impact of real estate foreclosures with Amortizing Participation Mortgages

Wojakowski

Ebrahim

Shackleton

2016

Journal of Banking & Finance

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A Generalized Valuation Model for Fixed-Rate Residential Mortgages

Cited by 304 publications

References 12 publications

An Empirical Test of a Two-Factor Mortgage Valuation Model: How Much Do House Prices Matter?

An Empirical Test of a Two-Factor Mortgage Valuation Model: How Much Do House Prices Matter?

Mortgage default and low downpayment loans: The costs of public subsidy

Reducing the impact of real estate foreclosures with Amortizing Participation Mortgages

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