An Empirical Test of a Two-Factor Mortgage Valuation Model: How Much Do House Prices Matter?

This article develops a two‐factor structural mortgage pricing model in which rational mortgage‐holders choose when to prepay and default in response to changes in both interest rates and house prices. We estimate the model using comprehensive data on the pool‐level termination rates for Freddie Mac...

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Veröffentlicht in:Real estate economics 2005-12, Vol.33 (4), p.681-710
Hauptverfasser: Downing, Chris, Stanton, Richard, Wallace, Nancy
Format: Artikel
Sprache:eng
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Zusammenfassung:This article develops a two‐factor structural mortgage pricing model in which rational mortgage‐holders choose when to prepay and default in response to changes in both interest rates and house prices. We estimate the model using comprehensive data on the pool‐level termination rates for Freddie Mac Participation Certificates issued between 1991 and 2002. The model exhibits a statistically and economically significant improvement over the nested one‐factor (interest‐rate only) model in its ability to match historical prepayment data. Moreover, the two‐factor model produces origination prices that are significantly closer to those quoted in the to‐be‐announced market than the one‐factor model. Our results have important implications for hedging mortgage‐backed securities.
ISSN:1080-8620
1540-6229
DOI:10.1111/j.1540-6229.2005.00135.x