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Modelling the instability of mortgage-backed prepayments

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  • Stavros Peristiani

Abstract

Prepayment plays a critical role in the performance of mortgage-backed securities. For this reason, market participants have devoted substantial resources to developing formal mathematical models of mortgage prepayment. Despite their considerable efforts, however, the forecasting effectiveness of these propriety models has been unreliable. This paper investigates the structure of the prepayment function. We demonstrate that the prepayment function is nonlinear and heteroskedastic. In particular, we find that prepayments are increasingly more volatile at higher interest rate spreads. Our analysis suggests that these unusual properties of pool prepayments are inherently caused by statistical aggregation.

Suggested Citation

  • Stavros Peristiani, 1998. "Modelling the instability of mortgage-backed prepayments," Research Paper 9804, Federal Reserve Bank of New York.
    • Handle: RePEc:fip:fednrp:9804
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    Keywords

    Securities; Mortgages;

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