The Valuation at Origination of Fixed Rate Mortgages with Default and Prepayment

THE JOURNAL OF REAL ESTATE FINANCE AND ECONOMICS, Vol 11

Posted: 25 Aug 1998

See all articles by James B. Kau

James B. Kau

University of Georgia - Department of Insurance, Legal Studies, Real Estate

Donald C. Keenan

University of Cergy-Pontoise; University of Georgia

Walter J. Muller

affiliation not provided to SSRN

James F. Epperson

University of Alabama

Abstract

This paper develops a model to rationally price fixed rate mortgages, using the arbitrage principles of option pricing theory. The paper incorporates amortization, prepayment and default in valuing the mortgage. Having completely specified the model, numerical procedures value the different features of the mortgage contract under a variety of economic conditions. The necessity of having both the interest rate and the house price as explanatory variables, due to the interaction of default and prepayment, is demonstrated. The numerical solutions presented center around mortgage pricing at origination. Thus, variations in the equilibrium contract rate are examined for differing economic conditions and changes in the contract. Finally, by presenting a complete model, the paper yields insights for the existence of common institutional practices.

JEL Classification: G12, G21

Suggested Citation

Kau, James B. and Keenan, Donald C. and Muller, Walter J. and Epperson, James F., The Valuation at Origination of Fixed Rate Mortgages with Default and Prepayment. THE JOURNAL OF REAL ESTATE FINANCE AND ECONOMICS, Vol 11, Available at SSRN: https://ssrn.com/abstract=6513

James B. Kau (Contact Author)

University of Georgia - Department of Insurance, Legal Studies, Real Estate ( email )

Athens, GA 30602-6254
United States
706-542-9110 (Phone)
706-542-4295 (Fax)

Donald C. Keenan

University of Cergy-Pontoise ( email )

33 Boulevard du Port
Cergy-Pontoise Cedex, Cedex 95011
France

University of Georgia ( email )

510 Brooks Hall
Athens, GA 30602
United States
706-542-3668 (Phone)

Walter J. Muller

affiliation not provided to SSRN

James F. Epperson

University of Alabama

Math Dept.
Tuscaloosa, AL 35487
United States

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