RT Journal Article
SR Electronic
T1 Valuing Fixed Rate Mortgage Loans with Default and Prepayment Options
JF The Journal of Fixed Income
FD Institutional Investor Journals
SP 7
OP 31
DO 10.3905/jfi.2007.683315
VO 16
IS 4
A1 Robert M. Dunsky
A1 Thomas S.Y. Ho
YR 2007
UL https://pm-research.com/content/16/4/7.abstract
AB There are three integral components to value a fixed rate mortgage loan: 1) the mortgagors' American straddle option on the underling loan, (a call option to refinance and a put option to default); 2) the mortgagors' heterogeneous behavior in exercising the options inefficiently; and 3) the market price of risk, [the option adjusted spread (OAS)]. Despite the dominance of mortgages in the capital market, scant research considers the valuation of mortgage loans while taking these three components into consideration, a contribution of this article. Specifically, this article uses a multinomial logit model to describe the mortgagors' behavior in dealing with the competing refinancing and default risks, and then utilizes a two factor arbitrage-free interest rate model to value the mortgages.TOPICS: Fixed income and structured finance, options, simulations