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Default and prepayment modelling in participating mortgages

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  • Varli, Yusuf
  • Yildirim, Yildiray

Abstract

Since the 2008 financial crisis, the mortgage market has been renovating its tools and instruments in order to avoid a new crisis. One such innovative instrument is the participating mortgage, in which the lender gains part of the net operating income and/or future appreciation. In this paper, we establish a financing model for participating mortgages, incorporating early termination options such as default and two prepayment clauses, defeasance and prepayment penalty. Later, we illustrate a detailed sensitivity analysis of the model. The values of early termination options depend on the choice of parameters in the model, as well as the term structure of short term rates. Finally, we show that a participation rate of 11.24% results in zero mortgage interest rate using the parameters in our simulation.

Suggested Citation

  • Varli, Yusuf & Yildirim, Yildiray, 2015. "Default and prepayment modelling in participating mortgages," Journal of Banking & Finance, Elsevier, vol. 61(C), pages 81-88.
    • Handle: RePEc:eee:jbfina:v:61:y:2015:i:c:p:81-88
    DOI: 10.1016/j.jbankfin.2015.09.003
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    References listed on IDEAS

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    Cited by:

    1. Yung-Tsung Lee & Tianxiang Shi, 2022. "Valuation of Reverse Mortgages with Surrender: A Utility Approach," The Journal of Real Estate Finance and Economics, Springer, vol. 65(4), pages 593-621, November.
    2. Shi, Tianxiang & Lee, Yung-Tsung, 2021. "Prepayment risk in reverse mortgages: An intensity-governed surrender model," Insurance: Mathematics and Economics, Elsevier, vol. 98(C), pages 68-82.
    3. Li, Zhiyong & Li, Aimin & Bellotti, Anthony & Yao, Xiao, 2023. "The profitability of online loans: A competing risks analysis on default and prepayment," European Journal of Operational Research, Elsevier, vol. 306(2), pages 968-985.
    4. Lok Man Michel Tong & Gianluca Marcato, 2018. "Modelling Competitive Mortgage Termination Option Strategies: Default vs Restructuring and Prepayment vs Defeasance," ERES eres2018_300, European Real Estate Society (ERES).

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    More about this item

    Keywords

    Participating mortgages; Credit risk; Prepayment risk;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • R30 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Real Estate Markets, Spatial Production Analysis, and Firm Location - - - General

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