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

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  • Kenneth B. Dunn
  • Chester S. Spatt
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    Abstract

    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. Copyright 2005 by the American Real Estate and Urban Economics Association

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    Bibliographic Info

    Article provided by American Real Estate and Urban Economics Association in its journal Real Estate Economics.

    Volume (Year): 33 (2005)
    Issue (Month): 4 (December)
    Pages: 595-617

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    Handle: RePEc:bla:reesec:v:33:y:2005:i:4:p:595-617

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    Cited by:
    1. Sumit Agarwal & John C Driscoll & David Laibson, 2008. "Optimal Mortgage Refinancing: A Closed Form Solution," Levine's Working Paper Archive 122247000000002021, David K. Levine.
    2. Agarwal, Sumit & Driscoll, John D. & Laibson, David I., 2012. "Optimal Mortgage Reï¬nancing: A Closed Form Solution," Scholarly Articles 9918811, Harvard University Department of Economics.
    3. Sumit Agarwal & Richard J. Rosen & Vincent Yao, 2013. "Why do borrowers make mortgage refinancing mistakes?," Working Paper Series WP-2013-02, Federal Reserve Bank of Chicago.
    4. Mayer, Chris & Piskorski, Tomasz & Tchistyi, Alexei, 2013. "The inefficiency of refinancing: Why prepayment penalties are good for risky borrowers," Journal of Financial Economics, Elsevier, vol. 107(3), pages 694-714.

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