IDEAS home Printed from
   My bibliography  Save this article

Behavioral Value Adjustments



    () (Cassa Depositi e Prestiti S.p.a., Rome, Italy)


    () (Cassa Depositi e Prestiti S.p.a., Rome, Italy)


Assets or liabilities with embedded prepayment/extension options can be subject to behavioral risk, due to the unpredictable exercise strategy followed by the option holder who does not act purely on the strength of financial convenience. When seen from the viewpoint of the option seller, such behavior results in a lower option value and an additional source of uncertainty in future cash flows. In this paper, we propose a general framework to model behavioral risk by taking advantage of a full parallel with credit portfolio modeling and by combining the features of option-based and intensity models. Our approach is micro-structural, meaning that the aggregate prepayment rate derives from the sum of individual decisions. In principle, a detailed characterization of the behavior of a pool of investors can be performed depending on available data. A particular emphasis is placed on the precise definition of behavioral risk and on the modeling of nonmarket factors, which may contribute significantly to the variance of future cash flows. Finally, we discuss the calibration of a behavioral risk premium and the pricing of contracts with embedded options by introducing the concept of behavioral risk adjustment (βVA), in line with the recent development of XVA methodology.

Suggested Citation

  • 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.
  • Handle: RePEc:wsi:ijtafx:v:20:y:2017:i:08:n:s0219024917500509
    DOI: 10.1142/S0219024917500509

    Download full text from publisher

    File URL:
    Download Restriction: Access to full text is restricted to subscribers.

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    1. Erwin Charlier & Arjan Van Bussel, 2003. "Prepayment Behavior of Dutch Mortgagors: An Empirical Analysis," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 31(2), pages 165-204, June.
    2. repec:wsi:ijtafx:v:07:y:2004:i:08:n:s0219024904002785 is not listed on IDEAS
    3. Davidson, Andrew & Levin, Alexander, 2014. "Mortgage Valuation Models: Embedded Options, Risk, and Uncertainty," OUP Catalogue, Oxford University Press, number 9780199998166.
    4. Antoon Pelsser & Mitja Stadje, 2014. "Time-Consistent And Market-Consistent Evaluations," Mathematical Finance, Wiley Blackwell, vol. 24(1), pages 25-65, January.
    5. Andreas Kolbe & Rudi Zagst, 2009. "Valuation of Mortgage-Backed Securities and Mortgage Derivatives: A Closed-Form Approximation," Applied Mathematical Finance, Taylor & Francis Journals, vol. 16(5), pages 401-427.
    6. James Kau & Donald Keenan & Alexey Smurov, 2006. "Reduced Form Mortgage Pricing as an Alternative to Option-Pricing Models," The Journal of Real Estate Finance and Economics, Springer, vol. 33(3), pages 183-196, November.
    7. repec:wsi:ijtafx:v:11:y:2008:i:06:n:s0219024908004968 is not listed on IDEAS
    8. Lütkebohmert, Eva & Gordy, Michael B., 2007. "Granularity adjustment for Basel II," Discussion Paper Series 2: Banking and Financial Studies 2007,01, Deutsche Bundesbank.
    9. Yongheng Deng & John M. Quigley & Robert Van Order, 2000. "Mortgage Terminations, Heterogeneity and the Exercise of Mortgage Options," Econometrica, Econometric Society, vol. 68(2), pages 275-308, March.
    10. Gan, Jumwu, 2009. "Burnout from pools to loans: Modeling refinancing prepayments as a self-selection process," MPRA Paper 15596, University Library of Munich, Germany.
    11. Xavier Gabaix & Arvind Krishnamurthy & Olivier Vigneron, 2007. "Limits of Arbitrage: Theory and Evidence from the Mortgage‐Backed Securities Market," Journal of Finance, American Finance Association, vol. 62(2), pages 557-595, April.
    12. Stadje, M.A. & Pelsser, A., 2014. "Time-Consistent and Market-Consistent Evaluations (Revised version of 2012-086)," Discussion Paper 2014-002, Tilburg University, Center for Economic Research.
    13. Andrew Green & Chris Kenyon, 2014. "KVA: Capital Valuation Adjustment," Papers 1405.0515,, revised Oct 2014.
    14. Mikhail Chernov & Brett R. Dunn & Francis A. Longstaff, 2018. "Macroeconomic-Driven Prepayment Risk and the Valuation of Mortgage-Backed Securities," Review of Financial Studies, Society for Financial Studies, vol. 31(3), pages 1132-1183.
    15. repec:wsi:ijtafx:v:09:y:2006:i:06:n:s0219024906003871 is not listed on IDEAS
    16. Francis A. Longstaff, 2005. "Borrower Credit and the Valuation of Mortgage-Backed Securities," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 33(4), pages 619-661, December.
    17. Vasiliki D. Skintzi & Apostolos‐Paul N. Refenes, 2005. "Implied correlation index: A new measure of diversification," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 25(2), pages 171-197, February.
    18. Dai, Min & Kwok, Yue Kuen & You, Hong, 2007. "Intensity-based framework and penalty formulation of optimal stopping problems," Journal of Economic Dynamics and Control, Elsevier, vol. 31(12), pages 3860-3880, December.
    19. 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.
    20. Stanton, Richard, 1995. "Rational Prepayment and the Valuation Mortgage-Backed Securities," Review of Financial Studies, Society for Financial Studies, vol. 8(3), pages 677-708.
    Full references (including those not matched with items on IDEAS)


    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:wsi:ijtafx:v:20:y:2017:i:08:n:s0219024917500509. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Tai Tone Lim). General contact details of provider: .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.