An Empirical Test of a Two-Factor Mortgage Valuation Model: How Much Do House Prices Matter?
AbstractThis article develops a two-factor structural mortgage pricing model in which rational mortgage-holders choose when to prepay and default in response to changes in both interest rates and house prices. We estimate the model using comprehensive data on the pool-level termination rates for Freddie Mac Participation Certificates issued between 1991 and 2002. The model exhibits a statistically and economically significant improvement over the nested one-factor (interest-rate only) model in its ability to match historical prepayment data. Moreover, the two-factor model produces origination prices that are significantly closer to those quoted in the to-be-announced market than the one-factor model. Our results have important implications for hedging mortgage-backed securities. Copyright 2005 by the American Real Estate and Urban Economics Association
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Bibliographic InfoArticle provided by American Real Estate and Urban Economics Association in its journal Real Estate Economics.
Volume (Year): 33 (2005)
Issue (Month): 4 (December)
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