We study the optimal recursive refinancing problem where a borrower minimizes his lifetime mortgage costs by repeatedly refinancing when rates drop sufficiently. Key factors affecting the optimal decision are the cost of refinancing and the possibility that the mortgagor may have to refinance at a premium rate because of his credit. The optimal recursive strategy often results in prepayment being delayed significantly relative to traditional models. Furthermore, mortgage values can exceed par by much more than the cost of refinancing. Applying the recursive model to an extensive sample of mortgage-backed security prices, we find that the implied credit spreads that match these prices closely parallel borrowers' actual spreads at the origination of the mortgage. These results suggest that optimal recursive models may provide a promising alternative to the reduced-form prepayment models widely used in practice.
Download Info
To download:
If you experience problems downloading a file, check if you have the
proper application to
view it first. Information about this may be contained
in the File-Format links below. In case of further problems read
the IDEAS help
page. Note that these files are not on the IDEAS
site. Please be patient as the files may be large.
For technical questions regarding this item, or to correct its listing, contact: (Christopher F. Baum).
Related research
Keywords:
References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
Did you know? You can include your works in the database easily by uploading them on the Munich Personal RePEc Archive (MPRA) if you do not have access to an institutional RePEc archive.