Continuous Workout Mortgages, Refinancing and Prepayments
Posted: 1 Dec 2010 Last revised: 11 Apr 2011
Date Written: April 8, 2011
We model Continuous Workout Mortgages (CWMs) in an economic environment with refinancings and prepayments by employing a market-observable variable such as the house price index. Our main results include: (a) explicit modelling of repayment and interest-only CWMs; (b) closed form formulae for mortgage payment and mortgage balance of a repayment CWM; (c) a closed form formula for the actuarially fair mortgage rate of an interest-only CWM. For repayment CWMs we extend our analysis to include two negotiable parameters: adjustable \"workout proportion\" and adjustable \"workout threshold.\" These results are of importance as they not only help understanding the mechanics of CWMs and estimating key contract parameters. Our results also provide guidance on how to mitigate systemic risk.
JEL Classification: L1
Suggested Citation: Suggested Citation