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Valuing Individual Mortgage Servicing Contracts: A Comparison between Adjustable Rate Mortgages and Fixed Rate Mortgages

  • Che-Chun Lin

    ()

    (Department of Quantitative Finance, National Tsing Hua University, 101, Sec. 2, Kuang Fu Road, Hsin Chu, 30013, Taiwan, R.O.C.)

  • Lan-Chih Ho

    ()

    (Department of Foreign Exchange, Central Bank of China, 2, Roosevelt Road, Sec. 1, Taipei, 100, Taiwan, R.O.C.)

This study constructs a valuation model from which an option-adjusted spread approach is employed to value individual mortgage servicing contracts for both adjustable rate and fixed rate mortgages. The valuation model is comprised of an exogenous OTS prepayment model, a stochastic interest rate process, and other servicing fees and costs, all of which jointly determine the servicing contract's future net cash flows and the rate at which to discount these cash flows. The sensitivity of the price of mortgage servicing rights to the changes in the economic environment is also analyzed. This work is potentially useful for servicers not only servicing mortgages but also servicing other types of loans in order to examine servicing policy-related issues.

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Article provided by World Scientific Publishing Co. Pte. Ltd. in its journal Review of Pacific Basin Financial Markets and Policies.

Volume (Year): 08 (2005)
Issue (Month): 01 ()
Pages: 131-146

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Handle: RePEc:wsi:rpbfmp:v:08:y:2005:i:01:p:131-146
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