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CMOs, Duration Risk and a New Mortgage

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    This article presents an alternative mortgage that retains the fixed-rate feature of a fixed-rate mortgage (FRM), but accelerates the principal amortization when interest rates rise, exposing the buyer to less duration risk in a rising interest rate environment. This mortgage, labeled the adjustable amortization mortgage (AAM), is shown to have lessened interest rate risk for the buyer as well as lower default risk, suggesting that it should be priced higher (at a lower rate of interest) than the typical FRM. It is also shown that mortgage-backed securities collateralized by an AAM have much less price volatility than mortgage-backed securities backed by FRMs.

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    Article provided by American Real Estate Society in its journal Journal of Real Estate Research.

    Volume (Year): 19 (2000)
    Issue (Month): 1 ()
    Pages: 73-103

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    Handle: RePEc:jre:issued:v:19:n:1:2000:p:73-103
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    American Real Estate Society Clemson University School of Business & Behavioral Science Department of Finance 401 Sirrine Hall Clemson, SC 29634-1323

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    Order Information: Postal: Diane Quarles American Real Estate Society Manager of Member Services Clemson University Box 341323 Clemson, SC 29634-1323
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    1. Wayne R. Archer & David C. Ling, 1993. "Pricing Mortgage-Backed Securities: Integrating Optimal Call and Empirical Models of Prepayment," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 21(4), pages 373-404.
    2. László Szerb, 1996. "The Borrower's Choice of Fixed and Adjustable Rate Mortgages in the Presence of Nominal and Real Shocks," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 24(1), pages 43-54.
    3. John C. Cox & Jonathan E. Ingersoll Jr. & Stephen A. Ross, 2005. "A Theory Of The Term Structure Of Interest Rates," World Scientific Book Chapters,in: Theory Of Valuation, chapter 5, pages 129-164 World Scientific Publishing Co. Pte. Ltd..
    4. Richard Stanton & Nancy Wallace, 1998. "Mortgage Choice: What's the Point?," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 26(2), pages 173-205.
    5. Haensly, Paul J & Springer, Thomas M & Waller, Neil G, 1993. "Duration and the Price Behavior of Fixed-Rate Level Payment Mortgages: An Analytical Investigation," The Journal of Real Estate Finance and Economics, Springer, vol. 6(2), pages 157-166, March.
    6. Kau, James B, et al, 1993. "Option Theory and Floating-Rate Securities with a Comparison of Adjustable- and Fixed-Rate Mortgages," The Journal of Business, University of Chicago Press, vol. 66(4), pages 595-618, October.
    7. Anderson, Gary A & Barber, Joel R & Chang, Chun-Hao, 1993. "Prepayment Risk and the Duration of Default-Free Mortgage-Backed Securities," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 16(1), pages 1-9, Spring.
    8. James B. Kau & Thomas M. Springer, 1993. "An Analysis of Financial and Nonfinancial Prepayment of GNMA Securities with a Varying Coefficient Model," Journal of Real Estate Research, American Real Estate Society, vol. 8(1), pages 69-86.
    9. Fama, Eugene F., 1984. "The information in the term structure," Journal of Financial Economics, Elsevier, vol. 13(4), pages 509-528, December.
    10. J. Sa-Aadu, 1987. "Consumer Welfare Under the Adjustable-Rate Mortgage: Some Empirical Evidence," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 15(3), pages 132-151.
    11. Sam R. Hakim, 1997. "Autonomous and Financial Mortgage Prepayment," Journal of Real Estate Research, American Real Estate Society, vol. 13(1), pages 1-16.
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