An Arbitrage-Free Estimate of Prepayment Option Prices in Fixed-Rate GNMA Mortgage-Backed Securities

In an efficient market, the no-arbitrage condition implies that the price difference between any two assets must be the market value of all differences in their cash flows. We use this logic to deduce the price of the prepayment option embedded in fixed-rate Government National Mortgage Association (GNMA) mortgage-backed securities. The option price equals the difference between an observed GNMA price and the cost of a synthetic, nonprepayable GNMA constructed from the least expensive portfolio of Treasury securities that exactly replicates the promised GNMA cash flow stream, assuming prepayment is precluded. We regress the option prices on variables found significant in previous prepayment studies, finding that five key regressors explain more than 90% of the prepayment option value in pooled time-series cross-sectional analysis. We also show that the time value of the prepayment option calculated by our method displays a pattern similar to that produced by the Black-Scholes (1973) option pricing model. An additional empirical result is the existence of negative option prices and negative time value of the option prices. We attribute these to the fact that homeowners sometimes exercise their prepayment options when they are out-of-the-money, and to refinancing transaction costs. Our method is independent of assumptions regarding interest rate processes and the homeowner's prepayment behavior, and it provides a benchmark for testing theoretical prepayment models.     

Determinants of Performance for Mortgage-Backed Securities Funds

This article examines the performance of mortgage-backed securities (MBS) mutual funds from January 1987 to June 1995. As a group, the MBS mutual funds underperform both the Salomon and Lehman Brothers MBS market benchmarks. The relative underperformance of the MBS mutual funds is due to poor securities selection and timing decisions. Fund expenses also contribute significantly to the underperformance, while fund load, turnover, management fees and other fund characteristics do not materially affect performance. The underperformance is found to be concentrated in several exceptionally bad months during the sample period. Testing indicates that the MBS mutual funds underperform the MBS benchmark during months of rising interest rates, but match the MBS benchmark during months of falling interest rates.     

Borrower Credit and the Valuation of Mortgage-Backed Securities

We study the valuation of mortgage-backed securities when borrowers may have to refinance at premium rates because of their credit. The optimal refinancing strategy often results in prepayment being delayed significantly relative to traditional models. Furthermore, mortgage values can exceed par by much more than the cost of refinancing. Applying the model to an extensive sample of mortgage-backed security prices, we find that the implied credit spreads that match these prices closely parallel borrowers' actual spreads at the origination of the mortgage. These results suggest that models that incorporate borrower credit into the analysis may provide a promising alternative to the reduced-form prepayment models widely used in practice.     

Hedging GNMA Mortgage-Backed Securities with T-Note Futures: Dynamic versus Static Hedging

This article proposes a dynamic hedging model for Government National Association Mortgage-Backed Securities (GNMA MBSs) that is free of the drawbacks associated with the static hedging strategies currently used. The simultaneity bias of the regression approach is dealt with by modeling the joint distribution of price changes of GNMA MBSs and 10-year Treasury-note futures. Error correction (EC) terms from cointegrating relationships are included in the conditional mean equations to preserve the long-term equilibrium relationship of the two markets. The time-varying variance–covariance structure of the two markets is modeled via a version of the bivariate generalized autoregressive conditionally heteroskedastic model (bivariate GARCH), which assures that the time-varying variance–covariance matrix is positive semidefinite for all time periods. This dynamic error-correction GARCH model is estimated using daily data on six different coupon GNMA MBSs. Dynamic cross-hedge ratios are obtained from the time-varying variance–covariance matrix using the 10-year Treasury-note futures contract as the hedging instrument. These ratios are evaluated in terms of both overall risk reduction and expected utility maximization. There is overwhelming evidence that dynamic hedge ratios are superior to static ones even when transaction costs are incorporated into the analysis. This conclusion holds for all six different coupon GNMA MBSs under investigation.     

Prepayment Behavior of Dutch Mortgagors: An Empirical Analysis

The suboptimal exercise of the prepayment option in a mortgage is relevant for mortgage pricing and the management of a mortgage portfolio. Construction of an accurate prepayment model requires quantification of driving factors such as seasoning, seasonality, refinance incentive and burnout. We focus on Dutch mortgages but also discuss the Dutch market in a European setting. Within the euro-denominated MBS market, the Dutch market is often referred to as the benchmark market. In our application we include typical Dutch market and contract characteristics such as the annual penalty-free prepayment of 10 to 20% of the original loan amount. We use loan-level historical data on mortgages originated between January 1989 and June 1999 to estimate separate models for two popular redemption types: savings mortgages and interest-only mortgages. In both models we allow for suboptimal prepayment behavior. The results clearly indicate that prepayment rates depend on interest rates and the age of the mortgage contract. Moreover, we find that burnout is an important element in describing the prepayment behavior of Dutch mortgagors.     

Commercial Mortgage-Backed Securities (CMBS) and Market Efficiency with Respect to Costly Information

Commercial mortgage-backed securities (CMBS) are complex asset-backed securities trading in markets that do not currently use derivatives pricing technology. This lack of usage is due to the complexity of the modeling exercise, and only the recent and costly availability of historical data. As such, CMBS markets provide a natural environment for the testing of market efficiency with respect to this costly information. Using this information, this article develops a CMBS pricing model to provide a joint test of the model and market efficiency. Backtesting our pricing model for 4 years, although there is some evidence of abnormal trading profits, we cannot reject the efficiency of the CMBS markets.     

A Lattice Approach to Pricing Fixed-Rate Mortgages with Default and Prepayment Options

Existing models on the pricing of default and prepayment options in fixed-rate mortgages either use numerical methds or they do not consider refinancing or other transaction costs involved in default and prepayment. We provide in this paper an application of the Boyle [1] lattice model to price secured debt with two risky assets. This model is simple, efficient and capable of considering the major types of transaction costs involved in prepayment and default. Using our model, we estimate the option values under a range of assumptions about the underlying parameters. We also provide some comparisons of the lattice model estimates to other models in the literature.     

Dividend Pricing Models and REITs

Dividend pricing/present value models relate current stock prices to expectations of future dividends. In this study we apply the West and Campbell–Shiller tests of the dividend pricing relation to an index of real estate investment trusts (REITs). REITs provide a unique test of these models since, during our study period, REITs were mandated to pay out at least 95% of taxable income as dividends. While our results complement previous research which finds that the dividend pricing model cannot be rejected if share repurchase is included as part of dividends, our data contain a much less significant amount of share repurchase, so that our approach to the issue of the viability of dividend pricing models offers an alternative insight. Our research suggests that, for our REIT population, dividend pricing models cannot be rejected.     

Mortgage Pricing: Some Provisional Empirical Results

We test some of the qualitative properties of mortgage pricing models. The models use option pricing techniques, focusing on prepayment as a call option. They imply a quite nonlinear relationship between mortgage price and coupon, interest rates and volatility. We test for both the first and second derivatives of the effects of these variables using data on Ginnie Mae mortgage backed securities. We find that the model is largely supported by the data.     

The Effect of Refinancing Costs and Market Imperfections on the Optimal Call Strategy and the Pricing of Debt Contracts

This article, which was originally written in 1986, develops a methodology for valuing mortgage-backed securities with refinancing costs. We solve simultaneously for the valuation of the mortgage-backed security (loan) and the borrower's refinancing strategy, pricing all coupon levels simultaneously. Because the borrower may refinance his or her loan and incur costs at many times in the future, the optimal refinancing decisions arise from an optimal dynamic strategy that reflects the costs of all potential future refinancings. Though the borrower faces multiple rounds of refinancing costs, the market value of the loan cannot exceed the call price plus a single round of refinancing costs.     

Ramsey Pricing and Regulator's Social Welfare Weights: An Empirical Application

The paper aims at uncovering the implicit regulator's social welfare weights within a generic Ramsey pricing structure allowing for distinct weights. The methodology is applied to U.S. water utilities for residential and non-residential water services, implying that the weights were virtually identical and thus no cross-subsidies occurred across those goods.     

The Asset Approach to Pricing Urban Land: Empirical Evidence

Many papers have attempted to explain Intelmetropolitan variations in the price of housing using multi-equation models of the metropolitan housing market. This paper uses a long-run equilibrium urban asset model to explain such variations. The model builds upon previous models that introduce uncertainty into the dynamic urban model of land conversion. The empirical results strongly support the asset approach to valuing land in urban areas.     

Movers and Shuckers: Interdependent Prepayment Decisions

We model competing risks of mortgage termination where the borrower faces a repeated choice to continue to pay, refinance the loan, move or default. Most previous empirical work on mortgage prepayment has ignored the distinction between prepayments triggered by refinancing and moving, combining them into a single prepayment rate. We show that financial considerations are the primary drivers of the refinance choice while homeowner characteristics have more influence on the move decision. We demonstrate that these differences are statistically significant and that combining these two distinct choices into a single measure of prepayment shifts coefficients toward zero and produces inaccurate predictions of aggregate termination rates. For example, a combined model underestimates the effect of the market price of the loan on refinancing; it misses entirely the opposite effects of borrower income on moving and refinancing. Our results suggest that existing prepayment models are inconsistent predictors of mobility-driven prepayment and underestimate the effect of market conditions and borrower characteristics on refinancing and housing decisions. Our findings have great significance to mortgage investors because mobility-driven prepayments are likely to be a more significant source of prepayments in thenext decade.     

Elective Mortgage Prepayment: Termination and Curtailment

Mortgage-prepayment risk underlies the structuring of mortgage-backed derivative securities, such as tranched real estate mortgage investment conduits. This prepayment comes either from mortgage termination or from curtailment, where the borrower retains the existing mortgage and prepays a portion. There are differences in cash flows from the two types of prepayment. In termination, the loan disappears from a pool, and the scheduled payment to investors in the pool is reduced. In curtailment, the loan survives, and the scheduled payment is unchanged but the term is reduced. There are implications for structuring mortgages and derivative securities. The prepayment decision is embedded in an in-tertemporal household utility maximization framework where choices are made between refinancing, making the regular payment, default or curtailment. Empirical results are presented for Government National Mortgage Association (GNMA) pools, and an algorithm is presented that separates the termination and curtailment components, facilitating the development of derivative securities.     

Optimal Sharing of Interest‐Rate Risk in Mortgage Contracts: The Effects of Potential Prepayment and Default

Much of the literature on the economics of mortgage markets has studied the fixed vs. adjustable‐rate mortgage choice made by individual borrowers. However, to decide if the outcome of such a choice is efficient or approximately so, it is necessary to explore the question of optimal risk‐sharing in mortgage contracts. But because only a small literature has studied this question, more research is clearly warranted. The present article helps fill this gap by developing a simplified version of Arvan and Brueckner's model, using it to characterize optimal contracts in the absence of mortgage termination, and then exploring how termination via prepayment or default affects optimal risk‐sharing. The broad conclusion of the analysis is that potential mortgage termination makes higher risk exposure for borrowers optimal.     

An Empirical Analysis of UK Credit Card Pricing

Previous studies show that the credit card market is imperfectly competitive. Using a reduced form hedonic model, the current paper demonstrates a relationship between credit card interest rates and product differentiation characteristics. The characteristics capture issuers’ attempts to: (1) screen/separate customers with different default risk characteristics and (2) better meet heterogeneous customer preferences. The results are consistent with risk-based pricing and monopolistic competition in the credit card market.     

浅谈输电服务的定价模式及方法

一 　　电力市场发展的重点在于将输电服务从电力生产 (发电 )和购买 (配电 )中分离出来，单独为其定价和签订合同，独立从事经营活动。同时，在买卖的基础上，明确地提出了输电服务等辅助性服务概念及其定价问题。输电服务的理论技术含量较高 ,分析起来比较复杂，本文汲取国际上对此问题的研究成果谈些看法。 　　总的来讲，输电服务就是将电能从电能的生产源 (独立发电厂和发电公司 )安全、经济、优质地输送到电能的使用者 (配电公司和大用户 )的过程。两者都应该是输电服务的客户，共同承担输电费用。在有些国家 (如英国 )其输电服务费用…     

Music for a Song: An Empirical Look at Uniform Pricing and Its Alternatives

With digital music as its context, this paper quantifies how much money would be made using alternatives to uniform pricing. Using survey‐based data on nearly 1,000 students' valuations of 100 popular songs in early 2008 and early 2009, we find that various alternatives can raise both producer and consumer surplus. Digital music revenue could be raised by between a sixth and a third relative to profit‐maximizing uniform pricing. While person‐specific uniform pricing can raise revenue by over 50 per cent, none of the non‐discriminatory schemes raise revenue's share of surplus above 40 per cent of total surplus.