Modeling Mortgages with Prepayment Penalties

19 Pages Posted: 7 Jan 2013

See all articles by Chih-Hsing Hung

Chih-Hsing Hung

Fortune Institute of Technology

Ming-Chi Chen

National Sun Yat-sen University - Department of Finance

Shyh-Weir Tzang

Asia University - Department of Finance

Date Written: September 15, 2012

Abstract

This paper uses a numerical simulation based on the Crank-Nicolson method to estimate the value of a fixed-rate mortgage (FRM) with embedded prepayment and non-defaultable options. We find that the value of the FRM will increase when interest rates decrease, increasing the incentive for borrowers to prepay the mortgage. This paper presents simulated results of prepayment penalties that may help financial institutions in enacting specific yield maintenance agreements and that may aid financial regulators in providing additional safety for financial lenders and borrowers.

Keywords: CIR Model, Crank-Nicolson, prepayment penalties, yield maintenance agreement

JEL Classification: G13, G21

Suggested Citation

Hung, Chih-Hsing and Chen, Ming-Chi and Tzang, Shyh-Weir, Modeling Mortgages with Prepayment Penalties (September 15, 2012). Emerging Markets Finance and Trade, Vol. 48, No. S.3, 2012, Available at SSRN: https://ssrn.com/abstract=2197288

Chih-Hsing Hung

Fortune Institute of Technology ( email )

Kaohsiung
Taiwan

Ming-Chi Chen

National Sun Yat-sen University - Department of Finance ( email )

No.70, Lianhai Rd., Gushan District,
Kaohsiung City
Taiwan

HOME PAGE: http://cm.nsysu.edu.tw/~mcchen/index.html

Shyh-Weir Tzang (Contact Author)

Asia University - Department of Finance ( email )

500, Liufeng Rd.,
Wufeng district,
Taichung, Taiwan 41354
Taiwan

HOME PAGE: http://www.asia.edu.tw/Main_pages/English_Pages/index_English.htm

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