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A Hybrid-Form Model For The Prepayment-Risk-Neutral Valuation Of Mortgage-Backed Securities

Author

Listed:
  • ANDREAS KOLBE

    (Merrill Lynch International, Merrill Lynch Financial Centre, 2 King Edward Street, London EC1A 1HQ, UK)

  • RUDI ZAGST

    (HVB-Institute for Mathematical Finance, Technische Universität München, Boltzmannstr. 3, D-85748 Garching (Munich), Germany)

Abstract

In this paper we present a prepayment-risk-neutral valuation model for fixed-rate Mortgage-Backed Securities. Our model is based on intensity models as used in credit-risk modeling and extends existing models for individual mortgage contracts in a proportional hazard framework. The general economic environment is explicitly accounted for in the prepayment process by an additional factor which we fit to the quarterly GDP growth rate in the US. In our risk-neutral setting we account for both the fears of refinancing understatement and turnover overstatement which sometimes result in higher option-adjusted spreads (OAS) for premiums and discounts respectively. We apply our prepayment-risk-neutral pricing approach to a sample of generic 30yr GNMA MBS pass-throughs from 1996 to 2006. Our empirical results indicate that the GDP growth factor adds explanatory power to the model.

Suggested Citation

  • Andreas Kolbe & Rudi Zagst, 2008. "A Hybrid-Form Model For The Prepayment-Risk-Neutral Valuation Of Mortgage-Backed Securities," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 11(06), pages 635-656.
    • Handle: RePEc:wsi:ijtafx:v:11:y:2008:i:06:n:s0219024908004968
    DOI: 10.1142/S0219024908004968
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    Citations

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    Cited by:

    1. Stephan Höcht & Rudi Zagst, 2010. "Pricing credit derivatives under stochastic recovery in a hybrid model," Applied Stochastic Models in Business and Industry, John Wiley & Sons, vol. 26(3), pages 254-276, May.
    2. Matteo Bissiri & Riccardo Cogo, 2017. "Behavioral Value Adjustments," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 20(08), pages 1-37, December.
    3. Chiang, Shu Ling & Yang, Tyler T. & Tsai, Ming Shann, 2016. "Assessing mortgage servicing rights using a reduced-form model: Considering the effects of interest rate risks, prepayment and default risks, and random state variables," Journal of Housing Economics, Elsevier, vol. 32(C), pages 29-46.

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