Pricing Mortgage-Backed Securities: Integrating Optimal Call and Empirical Models of Prepayment

Residential mortgage borrowers frequently appear to behave suboptimally with respect to their mortgage prepayment options. Many borrowers fail to exercise even well-into-the-money options while others prepay when the call option is out-of-the-money. To account for these apparently suboptimal prepayments, the recent trend in mortgage-backed securities research has been away from optimal call valuation models, in which the decision to exercise is determined endoge-nously, in favor of models in which prepayment behavior is exogenously specified based on empirical estimation. This paper develops a rational model of mortgage prepayment which incorporates both types of "non-optimal" prepayment and retains endogenous call. This enables the model to disentangle and compare the separate effects of the interest rate call, impeded by transaction costs, and of non-interest-rate driven prepayment. In addition, by recognizing heterogenous borrower transaction costs, the model presents a way to account more precisely for the varying prepayment lags associated with well-into-the-money call options and to account for the phenomenon of "burnout" within a mortgage pool. The paper includes an empirical test of the unbiasedness of the integrated pricing model by comparing simulated prices from our theoretical model to observed prices on traded Fannie Mae and GNMA securities.     

Environmental Regulation, Investment Timing, and Technology Choice

We test whether environmental regulation affects investment decisions, using Census data for individual paper mills. New mills in states with strict environmental regulations choose cleaner production technologies, with differences in air and water pollution regulation also influencing technology choice. Examining investment allocation across existing plants, we find that abatement and productive investment tend to be scheduled together. However, plants with high abatement investment over the entire period spend significantly less on productive capital. This seems to reflect both environmental investment 'crowding out' productive investment within a plant, and firms shifting investment towards plants facing less stringent abatement requirements.     

Randomized quasi-Monte Carlo methods in pricing securities

Today quasi-Monte Carlo methods are used successfully in computational finance and economics as an alternative to the Monte Carlo method. One drawback of these methods, however, is the lack of a practical way of error estimation. To address this issue several researchers introduced the so-called randomized quasi-Monte Carlo methods in the last decade. In this paper we will present a survey of randomized quasi-Monte Carlo methods, and compare their efficiencies with the efficiency of the Monte Carlo method in pricing certain securities. We will also investigate the effects of Box–Muller and inverse transformation techniques when they are applied to low-discrepancy sequences.     

Customers’ reactions to price increases: Do customer satisfaction and perceived motive fairness matter?

Most of the previous research on price changes has focused on price decreases. This article investigates the effects of price increases at an individual level. The authors argue that customers’ reactions to price increases (i.e., repurchase intentions) are strongly driven by two factors: the magnitude of the price increase and the perceived fairness of the motive for the price increase. In this context, the authors examine the role of customer satisfaction in influencing the impact of these two variables on repurchase intentions after a price increase. Their findings reveal that as satisfaction increases, the negative impact of the magnitude of a price increase is weakened. Furthermore, the results suggest that satisfaction moderates the impact of perceived motive fairness. The authors also find that the level of satisfaction can influence the valence of the perceived motives in response to a price increase. Christian Homburg (homburg@bwl.uni-mannheim.de) is a professor of marketing and chair of the Marketing Department at the University of Mannheim, Germany. He also serves as director of this university’s Institute for Market-Oriented Management. He holds master’s degrees in business administration and mathematics and a Ph.D. in business administration from the University of Karlsruhe, Germany. He also holds a habilitation degree from the University of Mainz, Germany. His research interests include market-oriented management, buyer-seller relationships, and business-to-business marketing. He has published in theJournal of Marketing, the Journal of Marketing Research, Strategic Management Journal, the Journal of the Academy of Marketing Science, and theInternational Journal of Research in Marketing. He is also the founder of Professor Homburg & Partners, an internationally operating management consulting firm. Wayne D. Hoyer (wayne.hoyer@bus.utexas.edu) is the the James L. Bayless/William S. Farish Fund Chair for Free Enterprise, the chairman of the Department of Marketing, and the director of the Center for Customer Insight in the McCombs School of Business at the University of Texas at Austin. He received his Ph.D., M.S., and B.A. from Purdue University in the area of consumer psychology. He has published more than 60 articles in various forums including theJournal of Consumer Research, theJournal of Marketing Research, theJournal of Marketing, the Journal of Advertising Research, and theJournal of Retailing. His research interests include customer insight and relationship management, consumer information processing and decision making (especially low-involvement decision-making), and advertising effects (most particularly, miscomprehension and the impact of humor). Nicole Koschate (nicole.koschate@bwl.uni-mannheim.de) is an assistant professor of marketing in the School of Business Administration at the University of Mannheim, Germany. She holds a double master’s degree in business administration and psychology and a Ph.D. in marketing from the University of Mannheim, Germany. Her current research areas include pricing, customer insight, dynamic issues in marketing phenomena, and buyerseller relationships. Her research appears in several outlets, including theJournal of Marketing.