Time-Varying Mortgage Prepayment Penalties
AbstractRecent empirical findings reveal that prepayment decisions of commercial property owners are slower than predicted by the pure options-pricing model (OPM). Borrower decisions appearing slow, however, may be quite rational when prepayment penalties of a time-varying nature are incorporated into the OPM. This article uses a competing risks OPM, adjusted for each of four different categories of prepayment penalties, to analyze borrower prepayment behavior. We find the value of delaying prepayment is often higher for mortgages with declining-rate penalties than for mortgages with static-rate penalties, frequently requiring a substantially higher interest rate spread to trigger a refinance. Multifamily loan prepayment records reveal the type of prepayment pattern that the adjusted OPM indicate should occur, reducing the gap between empirical findings and theoretical predictions. The results have implications for the specification of regressions fit to historical data, for the pricing of newly originated commercial mortgages, and for pricing in the single-family market where prepayment penalties are reemerging. Copyright 2001 by Kluwer Academic Publishers
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Bibliographic InfoArticle provided by Springer in its journal Journal of Real Estate Finance & Economics.
Volume (Year): 23 (2001)
Issue (Month): 2 (September)
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Web page: http://www.springerlink.com/link.asp?id=102945
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- Tsai, Ming-Shann & Liao, Szu-Lang & Chiang, Shu-Ling, 2009. "Analyzing yield, duration and convexity of mortgage loans under prepayment and default risks," Journal of Housing Economics, Elsevier, vol. 18(2), pages 92-103, June.
- Nicholas Sharp & Paul Johnson & David Newton & Peter Duck, 2009. "A New Prepayment Model (with Default): An Occupation-time Derivative Approach," The Journal of Real Estate Finance and Economics, Springer, vol. 39(2), pages 118-145, August.
- Muzaffer Akat & Brent W. Ambrose & Orhan Erdem & Yildiray Yildirim, 2012. "Valuing Default and Defeasence Option for Commercial Mortgage Backed Securities," Working Paper 01, Research and Business Development Department, Borsa Istanbul.
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