Electronic Resource
Springer
The journal of real estate finance and economics
12 (1996), S. 179-194
ISSN:
1573-045X
Keywords:
mortgage prepayment
;
refinancing
;
options
;
holding period
Source:
Springer Online Journal Archives 1860-2000
Topics:
Economics
Notes:
Abstract A discrete-time-option pricing model is developed to value a mortgage and its embedded prepayment option when the effective life of the mortgage is a random variable with a probability distribution of known parameters. The model can be applied when the borrower's ex ante expectation of his tenure follows any probability distribution bounded to the left at zero. The Gamma distribution is used to illustrate the model. The pricing model is further applied to determine the conditions under which financially motivated prepayment is optimal. The results show that the certainty model understates the Interest Rate Differential needed to justify prepayment (IRD) for short Expected Holding Period (EHP) borrowers and overstates the IRD for long EHP borrowers. When the EHP is relatively long, the certainty model provides relatively good estimates of IRD during the beginning years of the mortgage life. Under most other conditions, the estimates of the certainty holding period model are biased.
Type of Medium:
Electronic Resource
URL:
http://dx.doi.org/10.1007/BF00132266
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