Woodhead Behavior and the Pricing of Residential Mortgages
Mortgage terminations arise because borrowers exercise options. This paper investigates the apparently irrational behavior of those borrowers who do not terminate their mortgages even when the exercise value of the option is deeply in the money. We develop an option-based empirical model to analyze this phenomenon -- the behavior of irrational or boundedly rational â€œwoodheads.â€ Of course we do not observe â€œwoodheadsâ€ explicitly in any body of data. Instead, we analyze the correlates of unobserved heterogeneity within a large sample of mortgage holders. We develop a three-stage maximum likelihood (3SML) estimator using martingale transforms to estimate the competing risks of mortgage prepayment and default, recognizing unobserved heterogeneity which is due in part to the behavior of â€œwoodheads.â€ The extended model is clearly superior to alternatives on statistical grounds. We then analyze the economic implications of this more powerful model. We analyze the predictions of the model for the valuation and pricing of mortgage pools and mortgage-backed securities. Based upon an extensive Monte Carlo simulation, we find that the 3SML model yields prices for seasoned mortgage pools that deviate by 0.7 to 2 percent from more primitive estimates. The results indicate the empirical importance of heterogeneity and the implications of non-optimizing behavior for the valuation and pricing of mortgages and mortgage-backed securities.
|Date of creation:||29 Jun 2004|
|Contact details of provider:|| Postal: F502 Haas, Berkeley CA 94720-1922|
Phone: (510) 642-1922
Fax: (510) 642-5018
Web page: http://www.escholarship.org/repec/iber_bphup/
More information through EDIRC
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Qiang Dai & Kenneth J. Singleton, 2000.
"Specification Analysis of Affine Term Structure Models,"
Journal of Finance,
American Finance Association, vol. 55(5), pages 1943-1978, October.
- Qiang Dai & Kenneth J. Singleton, 1997. "Specification Analysis of Affine Term Structure Models," NBER Working Papers 6128, National Bureau of Economic Research, Inc.
- Qiang Dai & Kenneth J. Singleton, 1998. "Specification Analysis of Affine Term Structure Models," New York University, Leonard N. Stern School Finance Department Working Paper Seires 98-083, New York University, Leonard N. Stern School of Business-.
- repec:hrv:faseco:30747159 is not listed on IDEAS
- 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 309-331, May.
- Yongheng Deng, "undated". "Mortgage Termination: An Empirical Hazard Model with Stochastic Term Structure," Working Papers _002, University of California at Berkeley, Econometrics Laboratory Software Archive.
- Karl E. Case & Robert J. Shiller, 1987. "Prices of single-family homes since 1970: new indexes for four cities," New England Economic Review, Federal Reserve Bank of Boston, issue Sep, pages 45-56.
- Karl E. Case & Robert J. Shiller, 1987. "Prices of Single Family Homes Since 1970: New Indexes for Four Cities," NBER Working Papers 2393, National Bureau of Economic Research, Inc.
- Karl E. Case & Robert J. Shiller, 1987. "Prices of Single Family Homes Since 1970: New Indexes for Four Cities," Cowles Foundation Discussion Papers 851, Cowles Foundation for Research in Economics, Yale University.
- Heckman, James J. & Singer, Burton, 1984. "Econometric duration analysis," Journal of Econometrics, Elsevier, vol. 24(1-2), pages 63-132.
- Green, Jerry & Shoven, John B, 1986. "The Effects of Interest Rates on Mortgage Prepayments," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 18(1), pages 41-59, February.
- Jerry Green & John B. Shoven, 1983. "The Effects of Interest Rates on Mortgage Prepayments," NBER Working Papers 1246, National Bureau of Economic Research, Inc.
- Shoven, John & Green, Jerry, 1986. "The Effects of Interest Rates on Mortgage Prepayments," Scholarly Articles 3204664, Harvard University Department of Economics.
- Stanton, Richard Henry, 1996. "Unobservable Heterogeneity and Rational Learning: Pool-Specific versus Generic Mortgage-Backed Security Prices," The Journal of Real Estate Finance and Economics, Springer, vol. 12(3), pages 243-263, May.
- Hall, Arden, 2000. "Controlling for Burnout in Estimating Mortgage Prepayment Models," Journal of Housing Economics, Elsevier, vol. 9(4), pages 215-232, December.
- 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.
- Archer, Wayne R. & Ling, David C. & McGill, Gary A., 1996. "The effect of income and collateral constraints on residential mortgage terminations," Regional Science and Urban Economics, Elsevier, vol. 26(3-4), pages 235-261, June.
- Wayne Archer & David C. Ling & Gary A. McGill, 1995. "The Effect of Income and Collateral Constraints on Residential Mortgage Terminations," NBER Working Papers 5180, National Bureau of Economic Research, Inc.
- Todd R. Stinebrickner, 1999. "Estimation Of A Duration Model In The Presence Of Missing Data," The Review of Economics and Statistics, MIT Press, vol. 81(3), pages 529-542, August.
- Barberis, Nicholas & Shleifer, Andrei & Vishny, Robert, 1998. "A model of investor sentiment," Journal of Financial Economics, Elsevier, vol. 49(3), pages 307-343, September.
- Nicholas Barberis & Andrei Shleifer & Robert W. Vishny, 1997. "A Model of Investor Sentiment," NBER Working Papers 5926, National Bureau of Economic Research, Inc.
- Kau, James B. & Keenan, Donald C. & Muller III, Walter J. & Epperson, James F., 1995. "The Valuation at Origination of Fixed-Rate Mortgages with Default and Prepayment," The Journal of Real Estate Finance and Economics, Springer, vol. 11(1), pages 5-36, July.
- Eduardo S. Schwartz & Walter N. Torous, 1993. "Mortgage Prepayment and Default Decisions: A Poisson Regression Approach," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 21(4), pages 431-449. Full references (including those not matched with items on IDEAS)