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Mortgage Terminations: The Role of Conditional Volatility

  • David M. Harrison

    ()

    (University of Vermont, Burlington, VT 05405-0157)

  • Thomas G. Noordewier

    ()

    (University of Vermont, Burlington, VT 05405-0157)

  • K. Ramagopal

    ()

    (University of Vermont, Burlington, VT 05405-0157)

Registered author(s):

    This article is the winner of the Real Estate Finance manuscript prize (sponsored by Fannie Mae Foundation) presented at the 2001 American Real Estate Society Annual Meeting. Studies of mortgage termination decisions typically rely on a competing risks framework comparing defaults and prepayments. While useful tools have been developed to approximate the values of these competing default and prepayment options, the available metrics do not adequately account for the role of the conditional volatility of interest rates and housing prices in option valuation. Using a sample of 1,428 mortgage loan payment histories, this study finds that exponential GARCH estimates of the conditional volatility of housing prices and interest rates influence mortgage termination decisions in a predictable manner. Specifically, increased housing price volatility is shown to enhance default option values, while increased interest rate volatility is shown to enhance prepayment option values. Therefore, it would appear that conditional volatility represents a more refined input into the competing risks option framework.

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    File URL: http://pages.jh.edu/jrer/papers/pdf/past/vol23n0102/06.89_110.pdf
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    Article provided by American Real Estate Society in its journal Journal of Real Estate Research.

    Volume (Year): 23 (2002)
    Issue (Month): 1/2 ()
    Pages: 89-110

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    Handle: RePEc:jre:issued:v:23:n:1/2:2002:p:89-110
    Contact details of provider: Postal: 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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    1. Engle, Robert F, 1982. "Autoregressive Conditional Heteroscedasticity with Estimates of the Variance of United Kingdom Inflation," Econometrica, Econometric Society, vol. 50(4), pages 987-1007, July.
    2. Kim, Dongcheol & Kon, Stanley J, 1994. "Alternative Models for the Conditional Heteroscedasticity of Stock Returns," The Journal of Business, University of Chicago Press, vol. 67(4), pages 563-98, October.
    3. 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.
    4. Tim Bollerslev, 1986. "Generalized autoregressive conditional heteroskedasticity," EERI Research Paper Series EERI RP 1986/01, Economics and Econometrics Research Institute (EERI), Brussels.
    5. Deng, Yongheng, 1997. "Mortgage Termination: An Empirical Hazard Model with a Stochastic Term Structure," The Journal of Real Estate Finance and Economics, Springer, vol. 14(3), pages 309-31, May.
    6. Nelson, Daniel B, 1991. "Conditional Heteroskedasticity in Asset Returns: A New Approach," Econometrica, Econometric Society, vol. 59(2), pages 347-70, March.
    7. Dennis R. Capozza & Dick Kazarian & Thomas A. Thomson, 1998. "The Conditional Probability of Mortgage Default," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 26(3), pages 259-289.
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