Universal Asymptotic Behavior of Mortgage Prepayments

California Tech Working Paper No. 68-2307

7 Pages Posted: 20 Mar 2002

See all articles by Mark B. Wise

Mark B. Wise

California Institute of Technology

Vineer Bhansali

LongTail Alpha, LLC

Abstract

Mortgage prepayments play a crucial role in the pricing and hedging of mortgage backed securities. An important feature of mortgage prepayment modeling is burnout; as time goes on those borrowers who have the greatest tendency to refinance are removed from the pool leaving only those that are less likely to refinance. In this paper we examine the implications of burnout on the late time prepayment rate using rather general assumptions. Analytic formulas are derived for the average prepayment rate in the N'th month, P_N, and the fraction of borrowers remaining in the pool in the N'th month, y_N. In the case where the incentive to refinance, and other relevant economic factors, are constant these results are particularly simple. For example, P_N=p+(1-p)/N+..., where p is a constant and the ellipses denote terms suppressed by more powers of 1/N or exponentially suppressed. The term of order 1/N indicates that burnout causes the probability of prepayment to decrease as a very simple function of N.

Keywords: Mortgage, prepayments, burnout

JEL Classification: G00, C50

Suggested Citation

Wise, Mark B. and Bhansali, Vineer, Universal Asymptotic Behavior of Mortgage Prepayments. California Tech Working Paper No. 68-2307. Available at SSRN: https://ssrn.com/abstract=304074 or http://dx.doi.org/10.2139/ssrn.304074

Mark B. Wise (Contact Author)

California Institute of Technology ( email )

Pasadena, CA 91125
United States
626-395-6687 (Phone)
626-568-8473 (Fax)

Vineer Bhansali

LongTail Alpha, LLC ( email )

500 Newport Center Drive
Suite 820
Newport Beach, CA 92660
United States

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