The valuation at origination of fixed-rate mortgages with default and prepayment |
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Authors: | James B Kau Donald C Keenan Walter J Muller III James F Epperson |
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Institution: | (1) Department of Insurance, Legal Studies and Real Estate, The University of Georgia, 30602 Athens, GA;(2) The University of Georgia, 30602 Athens, GA;(3) 30303 NationsBank, Atlanta, GA;(4) University of Alabama-Huntsville, 35899 Huntsville, AL |
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Abstract: | This paper develops a model to rationally price fixed-rate mortgages, using the arbitrage principles of option pricing theory. The paper incorporates amortization, prepayment and default in valuing the mortgage. Having completely specified the model, numerical procedures value the different features of the mortgage contract under a variety of economic conditions. The necessity of having both the interest rate and the house price as explanatory variables, due to the interaction of default and prepayment, is demonstrated. The numerical solutions presented center around mortgage pricing at origination. Thus, variations in the equilibrium contract rate are examined for differing economic conditions and changes in the contract. Finally, by presenting a complete model, the paper yields insights for the existence of common institutional practices. |
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Keywords: | mortgage pricing origination default prepayment |
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