Tyler T. Yang

An Analysis of the "Ex Ante" Probabilities of Mortgage Prepayment and Default

Observed mortgage prepayment and default rates have been far different than the ruthless option exercise rates predicted by contingent claims models of mortgage pricing. The discrepancies have been attributed to both the competing-risk nature of prepayment and default and to transactions costs. This paper tries a different means of reconciliation. We introduce a third stochastic process, household income, into the usual pricing model that includes only the spot interest rate and the house price. The presence of income allows considering consumption-theoretic determinants of termination. The role of mortgage underwriting rules in restricting optimal prepayment is also explicitly modeled. Numerical ex ante prepayment and default rates based on the theoretical model come much closer to historical experience. Copyright American Real Estate and Urban Economics Association.

Pricing the competing risks of mortgage default and prepayment in stochastic metropolitan economies

Outlines previous research relevant to the risks involved in residential mortgages and suggests some reasons for the gap between theory and market practice. Develops a model which adds household income, ability to pay problems and mortgage underwriting constraints to the standard pricing models, using a combination of Monte Carlo simulation and the backward finite difference method to apply it to data on house prices, income and interest rates for 62 US metropolitan areas. Discusses the results which suggest that prepayment risk dominates default risk in all except very low growth housing markets. Adds that increasing loan‐to‐value levels decrease loan values in low growth markets, slightly increase them in high growth/low volatility markets (due to decline in prepayment risk), but have little impact on high growth/high volatility markets (because they are offset by changes in default and prepayment costs). Considers the practical implications of the findings, e.g. for portfolio managers.

Mortgage Prepayment Float: Pricing and Risk Analysis

TYLER T. YANG is with Price Waterhouse. is article is a theoretical and empirical analysis of the value of mortgage servicers’ net prepayment float. Net prepayment float is the investment income on prepaid principal and interest prior to remittance to the ultimate mortgage note holder. Float income is potentially an important component of servicers’ overall profitability, but its value and risk cannot be estimated easily. We develop a pricing model of float and use it to empirically analyze the value and risk of float during a thirteen-year sample period. For a fee, a mortgage servicer performs the role of managing the mortgage payment process for an investor or the ultimate purchaser of the mortgage note. Servicing includes collection of monthly payments from borrowers, the transfer of principal and interest payments to investors, the management of escrow accounts, and the handhng of delinquencies and foreclosures.2 The servicing fee varies with the type of loan, but ranges between 25 and 50 basis points of the unpaid balance. Occasionally, servicers earn additional income from late fee charges assessed against delinquent borrowers. In addition, servicing provides a valuable customer base for loan and deposit products, insurance, and investment services that have the potential for materially influencing the returns and risks of mortgage lenders. In short, the value of the servicing contract is a significant component of the overall profitability of primary mortgage lenders, One aspect of that profit is the value of income received from the mortgage flow. The value and volatility of float income depends upon prepayments of the loan being serviced (see Rosenblatt [1994]). On the positive side, a servicer earns significant prepayment float income by investing

Valuing Fixed‐Income Options and Mortgage‐Backed Securities with Alternative Term Structure Models

To value mortgage-backed securities and options on fixed-income securities, it is necessary to make assumptions regarding the term structure of interest rates. We assume that the multi-factor fixed parameter term structure model accurately represents the actual term structure of interest rates, and that the values of mortgage-backed securities and discount bond options derived from such a term structure model are correct. Differences in the prices of interest rate derivative securities based on single-factor term structure models are therefore due to pricing bias resulting from the term structure model. The price biases that result from the use of single-factor models are compared and attributed to differences in the underlying models and implications for the selection of alternative term structure models are considered. Copyright Blackwell Publishers Ltd 1999.

Mortgage defaults and risk-based capital: post-global financial crisis development and implications for emerging markets

This innovative book analyses the role played by real estate markets in global financial stability and examines the fragile link between the two. Through what transmission channels do housing market cycles influence broader economic systems? How has the Global Financial Crisis shifted our view and understanding of these linkages? This detailed book answers these questions in an international comparative perspective. Specific topics covered include macroeconomic transmission channels of the housing cycle, the role of housing in the finance system, construction financing as a cycle amplifier, and various related public policy issues such as the policy remedies needed to deal with housing and mortgage-driven crises.

Interest-Only and Principal-Only Mortgage Strips as Interest-Rate Contingent Claims

Interest-only (IO) and principal-only (PO) mortgage strips are valued in a stochastic interest-rate environment. The prepayment rate of the underlying mortgages is affected by two considerations not present in the “pure” financially rational model: (1) The property owners holding period is assumed to follow a Gamma distribution, resulting in the possibility of prepayment due to the sale of the property (i.e., prepayment that is “too early” based on market interest rates); and (2) borrowers are assumed to face heterogeneous transaction costs related to refinancing the existing mortgage, and delay refinancing when market conditions make it optimal to do so (refinancing “too late”). Properties of IO/PO strips are identified by the finite difference method.