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Pricing Mortgages: An Interpretation of the Models and Results

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  • Patric H. Hendershott
  • Robert Van Order

Abstract

Mortgages, like all debt securities, can be viewed as risk-free assets plus or minus contingent claims that can be usefully viewed as options. The most important options are: prepayment, which is a call option giving the borrower the right to buy back the mortgage at par, and default, which is a put option giving the borrower the right to sell the house in exchange for the mortgage. This paper reviews and interprets the large and growing body of literature that applies recent results of option pricing models to mortgages. We also provide a critique of the models and suggest directions for future research.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 2290.

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Date of creation: Jun 1987
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Publication status: published as From Journal of Financial Services Research, Vol. 1, No. 1, pp. 19-55,(October 1987).
Handle: RePEc:nbr:nberwo:2290

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References

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  1. James B. Kau & Donald C. Keenan & Walter J. Muller & James F. Epperson, 1985. "Rational Pricing of Adjustable Rate Mortgages," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 13(2), pages 117-128.
  2. Craig Swan, 1982. "Pricing Private Mortgage Insurance," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 10(3), pages 276-296.
  3. Arden R. Hall, 1985. "Valuing the Mortgage Borrower's Prepayment Option," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 13(3), pages 229-247.
  4. Shoven, John & Green, Jerry, 1986. "The Effects of Interest Rates on Mortgage Prepayments," Scholarly Articles 3204664, Harvard University Department of Economics.
  5. Brennan, Michael J. & Schwartz, Eduardo S., 1977. "Savings bonds, retractable bonds and callable bonds," Journal of Financial Economics, Elsevier, vol. 5(1), pages 67-88, August.
  6. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
  7. Richard, Scott F., 1978. "An arbitrage model of the term structure of interest rates," Journal of Financial Economics, Elsevier, vol. 6(1), pages 33-57, March.
  8. Stephen A. Buser & Patric H. Hendershott & Anthony B. Sanders, 1984. "Pricing Rate Caps on Default-Free Adjustable-Rate Mortgages," NBER Working Papers 1525, National Bureau of Economic Research, Inc.
  9. Brown, Stephen J & Dybvig, Philip H, 1986. " The Empirical Implications of the Cox, Ingersoll, Ross Theory of the Term Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 41(3), pages 617-30, July.
  10. Dothan, L. Uri, 1978. "On the term structure of interest rates," Journal of Financial Economics, Elsevier, vol. 6(1), pages 59-69, March.
  11. Campbell, Tim S & Dietrich, J Kimball, 1983. " The Determinants of Default on Insured Conventional Residential Mortgage Loans," Journal of Finance, American Finance Association, vol. 38(5), pages 1569-81, December.
  12. James F. Epperson & James B. Kau & Donald C. Keenan & Walter J. Muller, 1985. "Pricing Default Risk in Mortgages," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 13(3), pages 261-272.
  13. Masulis, Ronald W., 1982. "Government intervention in the mortgage market : A study of anti-redlining regulations," Journal of Monetary Economics, Elsevier, vol. 10(2), pages 191-213.
  14. Dunn, Kenneth B & McConnell, John J, 1981. "Valuation of GNMA Mortgage-Backed Securities," Journal of Finance, American Finance Association, vol. 36(3), pages 599-616, June.
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Cited by:
  1. Amy Cutts & Robert Order, 2004. "On the Economics of Subprime Lending," The Journal of Real Estate Finance and Economics, Springer, vol. 30(2), pages 167-196, November.
  2. Terrence M. Clauretie & Mel Jameson, 1995. "Residential Loan Renegotiation: Theory and Evidence," Journal of Real Estate Research, American Real Estate Society, vol. 10(2), pages 153-162.
  3. Sumit Agarwal & John C. Driscoll & David Laibson, 2007. "Optimal Mortgage Refinancing: A Closed Form Solution," NBER Working Papers 13487, National Bureau of Economic Research, Inc.
  4. Agarwal, Sumit & Chomsisengphet, Souphala & Hassler, Olivier, 2005. "The impact of the 2001 financial crisis and the economic policy responses on the Argentine mortgage market," Journal of Housing Economics, Elsevier, vol. 14(3), pages 242-270, September.
  5. Michael LaCour-Little & Gregory H. Chun, 1999. "Third Party Originators and Mortgage Prepayment Risk: An Agency Problem?," Journal of Real Estate Research, American Real Estate Society, vol. 17(1), pages 55-70.
  6. Patric H. Hendershott, . "Uses of Equilibrium Models in Real Estate Research," Research in Financial Economics 9612, Ohio State University.
  7. Dressler, Jonathan B. & Stokes, Jeffrey R., 2006. "Mortgage Termination at AgChoice Farm Credit," Proceedings: 2006 Agricultural and Rural Finance Markets in Transition, October 2-3, 2006; Washington, DC 133077, Regional Research Committee NC-1014: Agricultural and Rural Finance Markets in Transition.
  8. 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.
  9. Harding, John P., 2000. "Mortgage Valuation with Optimal Intertemporal Refinancing Strategies," Journal of Housing Economics, Elsevier, vol. 9(4), pages 233-266, December.
  10. Ashok Bardhan & Raša Karapandža & Branko Urošević, 2006. "Valuing Mortgage Insurance Contracts in Emerging Market Economies," The Journal of Real Estate Finance and Economics, Springer, vol. 32(1), pages 9-20, February.
  11. John Clapp & Yongheng Deng & Xudong An, 2005. "Unobserved heterogeneity in Models of Competing Mortgage Termination Risks," Working Paper 8585, USC Lusk Center for Real Estate.
  12. John M. Harris, Jr. & G. Stacy Sirmans, 1987. "Discount Points, Effective Yields and Mortgage Prepayments," Journal of Real Estate Research, American Real Estate Society, vol. 2(2), pages 97-104.
  13. Yongheng Deng & John M. Quigley & Robert Van Order, 1995. "Mortgage Default and Low Downpayment Loans: The Costs of Public Subsidy," NBER Working Papers 5184, National Bureau of Economic Research, Inc.
  14. Murphy, Austin, 2000. "A comparative analysis of the price-process model of mortgage valuation," Review of Financial Economics, Elsevier, vol. 9(2), pages 65-82, December.
  15. Xudong An & John Clapp & Yongheng Deng, 2005. "Omitted Mobility Characteristics and Property Market Dynamics: Application to Mortgage Termination," Working Paper 8584, USC Lusk Center for Real Estate.
  16. Yongheng Deng & Della Zheng & Changfeng Ling, 2005. "An Early Assessment of Residential Mortgage Performance in China," The Journal of Real Estate Finance and Economics, Springer, vol. 31(2), pages 117-136, September.
  17. Jill Wetmore & Chiaku Ndu, 2006. "Mortgage Refinancing Activity: An Explanation [1990–2001]," The Journal of Real Estate Finance and Economics, Springer, vol. 33(1), pages 75-86, August.
  18. repec:fip:fedreq:y:2012:i:2q:p:111-138:n:vol.98no.2 is not listed on IDEAS
  19. Robert Eisenbeis, 2000. "History of the Journal of Financial Services Research," Journal of Financial Services Research, Springer, vol. 18(2), pages 103-107, December.
  20. Goldberg, Gerson M. & Harding, John P., 2003. "Investment characteristics of low- and moderate-income mortgage loans," Journal of Housing Economics, Elsevier, vol. 12(3), pages 151-180, September.

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