Default and Prepayment Modelling in Participating Mortgages

30 Pages Posted: 9 Jun 2014 Last revised: 28 Dec 2015

See all articles by Yusuf Varli

Yusuf Varli

Borsa İstanbul - Research Dept.

Yildiray Yildirim

Zicklin School of Business, Baruch College - The City University of New York

Date Written: December 27, 2015

Abstract

Since the 2007 financial crisis, the mortgage market has been renovating its tools and instruments in order to avoid a new crisis. One such innovative instrument is the participating mortgage, in which the lender gains part of the net operating income and/or future appreciation. In this paper, we establish a financing model for participating mortgages, incorporating early termination options such as default and two prepayment clauses, defeasance and prepayment penalty. Later, we illustrate a detailed sensitivity analysis and get practical results. The values of early termination options depend on the choice of parameters in the model, as well as the term structure of short term rates. Finally, we show that a participation rate of 11.24% results in zero mortgage interest rate using the parameters in our simulation.

Keywords: Participating mortgages, credit risk, prepayment risk

JEL Classification: G21, G32, R30

Suggested Citation

Varli, Yusuf and Yildirim, Yildiray, Default and Prepayment Modelling in Participating Mortgages (December 27, 2015). Available at SSRN: https://ssrn.com/abstract=2447452 or http://dx.doi.org/10.2139/ssrn.2447452

Yusuf Varli

Borsa İstanbul - Research Dept. ( email )

Reşitpaşa mh.
Tuncay Artun cd.
Istanbul, 34467
Turkey

Yildiray Yildirim (Contact Author)

Zicklin School of Business, Baruch College - The City University of New York ( email )

55 Lexington Ave., Box B13-260
New York, NY 10010
United States

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