Second Mortgages: Valuation and Implications for the Performance of Structured Financial Products

41 Pages Posted: 28 Aug 2016

See all articles by Andra C. Ghent

Andra C. Ghent

University of Utah - David Eccles School of Business

Kristian R. Miltersen

Copenhagen Business School

Walter N. Torous

Massachusetts Institute of Technology

Date Written: August 26, 2016

Abstract

We provide an analytic valuation framework to value second mortgages and first lien mortgages when owners can take out a second lien. We then use the framework to value mortgage-backed securities (MBS) and, in particular, quantify the greater risk associated with MBS backed by first liens that have "silent seconds''. Rating securities without accounting for the equity extraction option results in much higher ratings than warranted by expected loss. While the senior tranche’s rating should be A1 rather than Aaa in our benchmark calibration, the big losers from the equity extraction option are the mezzanine tranches who get wiped out.

Keywords: Mortgage-Backed Securities (MBS), Mortgage Valuation, Credit Ratings.

JEL Classification: G12, G21, G23, G24

Suggested Citation

Ghent, Andra C. and Miltersen, Kristian Risgaard and Torous, Walter N., Second Mortgages: Valuation and Implications for the Performance of Structured Financial Products (August 26, 2016). Available at SSRN: https://ssrn.com/abstract=2830582 or http://dx.doi.org/10.2139/ssrn.2830582

Andra C. Ghent (Contact Author)

University of Utah - David Eccles School of Business ( email )

1645 E Campus Center Dr
Salt Lake City, UT 84112-9303
United States

Kristian Risgaard Miltersen

Copenhagen Business School ( email )

Solbjerg Plads 3
Frederiksberg C, DK - 2000
Denmark

Walter N. Torous

Massachusetts Institute of Technology ( email )

Center for Real Estate and Sloan School
Cambridge, MA 02138
United States

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