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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. 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.
  2. Shoven, John & Green, Jerry, 1986. "The Effects of Interest Rates on Mortgage Prepayments," Scholarly Articles 3204664, Harvard University Department of Economics.
  3. 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.
  4. 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.
  5. Craig Swan, 1982. "Pricing Private Mortgage Insurance," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 10(3), pages 276-296.
  6. Dothan, L. Uri, 1978. "On the term structure of interest rates," Journal of Financial Economics, Elsevier, vol. 6(1), pages 59-69, March.
  7. 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.
  8. 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.
  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. 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.
  11. 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.
  12. 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.
  13. 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.
  14. 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.
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Citations

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Cited by:
  1. Sumit Agarwal & John C Driscoll & David Laibson, 2008. "Optimal Mortgage Refinancing: A Closed Form Solution," Levine's Working Paper Archive 122247000000002021, David K. Levine.
  2. Deng, Yongheng & Quigley, John M. & Van Order, Robert & Mac, Freddie, 1996. "Mortgage default and low downpayment loans: The costs of public subsidy," Regional Science and Urban Economics, Elsevier, vol. 26(3-4), pages 263-285, June.
  3. 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.
  4. 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.
  5. Robert Eisenbeis, 2000. "History of the Journal of Financial Services Research," Journal of Financial Services Research, Springer, vol. 18(2), pages 103-107, December.
  6. 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.
  7. 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.
  8. 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.
  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. repec:fip:fedreq:y:2012:i:2q:p:111-138:n:vol.98no.2 is not listed on IDEAS
  11. 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.
  12. Patric H. Hendershott, 1997. "Uses of equilibrium models in real estate research," Journal of Property Research, Taylor & Francis Journals, vol. 14(1), pages 1-13, January.
  13. 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.
  14. 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.
  15. 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.
  16. 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.
  17. 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.

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