MORTGAGE BACKED SECURITIES

The Prepayment Risk in Mortgage Backed Securities

Acknowledgement

Abstract

One of the major developments in real estate finance during the 1990s was the emergence of a viable market for commercial mortgage backed securities. The growth in this market has spurred greater interest in empirical and theoretical research on commercial mortgage default and prepayment. We employ a competing risks model to examine the default and prepayment behavior of commercial loans underlying CMBS deals. We find that changes in the yield curve have a direct impact on the probability of mortgage termination. Furthermore, we do not find any statistical relationship between LTV and prepayment or default.

Table of Contents

1CHAPTER 16

1.1Introduction6

2CHAPTER 211

2.1Literature Review11

2.1.1The market for mortgage pass-through securities15

2.1.2The dangers of mortgage pass-throughs17

2.1.3The implication of prepayment risk19

2.1.4The Secondary Market for Residential Mortgages21

2.1.4.1 The Growth of Securitization21

2.1.4.2 Mortgage Market Segmentation23

2.1.4.3 Securitization in Europe24

3CHAPTER 326

3.1Methodology26

3.2Data31

3.2.1Competing Risk Model34

3.2.2Empirical Model36

4CHAPTER 442

4.1Results and Findings42

4.1.1Empirical Results42

5CHAPTER 546

5.1Discussion46

5.1.1Fixed-Rate, Level-Payment, Fully Amortized Mortgage48

5.1.2Adjustable-Rate Mortgages50

5.1.3Balloon Mortgages51

5.1.4Barra's Implied Prepayment risk form for MBSs53

5.1.5Modeling disperses only and the require for a new factor54

5.1.6Separating concern rate risk from prepayment risk55

5.1.7Comparing the spreads-only and inferred prepayment models57

5.1.8Mortgage-Backed Securities Primer58

5.1.9Valuation Techniques62

6CHAPTER 666

6.1Conclusion66

REFERENCES70

LIST OF TABLES74

Chapter 1

Introduction

Levin and Davidson (2005) issue out, although, that random oscillations of genuine prepayments round the model's propositions should be diversifiable and should not lead to any added risk reimbursement premium. They therefore understand the OAS as a reimbursement for non-diversifiable doubt which is methodical in tendency and unexplained by an else best-guess prepayment model. Kupiec and Kah (1999) contend in a rather alike main heading and ascribe the reality of the OAS to the omission of significant prepayment components in the risk-neutral Monte-Carlo replication process. Indeed, in the risk-neutral charge structure there is no scope for financial risk premia since under a risk-neutral martingale assess all swapped assets are anticipated to profit from the risk-free rate.

These latest concerns have administered researchers' vigilance to the likelihood assess affiliated with the prepayment process. Kagraoka (2002) indicates that, ”surprisingly”, this has not been an topic before regardless of the detail that practitioners have been using the OAS method for decades, emphasizing that it is, of course, not certain that the prepayment method under the martingale assess is matching to that under the genuine world measure.

Meanwhile, the latest improvement in borrowing risk modelling have inspired a sequence of new study papers which are worried with the valuation of mortgage borrowings and MBS utilising advances scrounged from this field. While Nakagawa and Shouda (2005) use a functional set about in which they characterise an unobservable prepayment cost method which can be in evaluation to the firm worth method in the default risk modelling publications, Goncharov (2005) concerns an intensity-based set about as utilised in reducedform borrowing risk forms to assess mortgage contracts.

When producing the transition from the valuation of one-by-one mortgage agreements to MBS, the inquiry arises if all mortgagors in a pool with the identical lend characteristics can be presumed to characteristic unaligned, homogeneous prepayment and default behaviour. It is a well renowned detail in the mortgage markets that past refinancing ...