Skip to main content

Unobservable heterogeneity and rational learning: Pool-specific versus generic mortgage-backed security prices


Previous mortgage prepayment and valuation models assume that two mortgage pools with the same observable characteristics should behave indistinguishably. However, even pools with apparently identical characteristics often exhibit markedly different prepayment behavior. The sources of this heterogeneity may be unobservable, but we can infer information about a pool from its prepayment behavior over time. This article develops a methodology for using this information to calculate pool-specific mortgage-backed security prices. Knowledge of these prices is important both for portfolio valuation and for determining the cheapest pool to deliver when selling mortgagebacked securities. We find that unobservable heterogeneity between mortgage pools is statistically significant, and that pool-specific prices, calculated for a sample of outwardly identical mortgage pools between 1983 and 1989, may differ greatly from any single representative price.

This is a preview of subscription content, access via your institution.


  1. Akerlof, G. (1970). “The Market for Lemons: Quality Uncertainty and the Market Mechanism,”Quarterly Journal of Economics 89, 488–500.

    Google Scholar 

  2. Amemiya, T. (1985).Advanced Econometrics. Cambridge, MA: Harvard University press.

    Google Scholar 

  3. Bartlett, W. (1989).Mortgage-Backed Securities: Products, Analysis, Trading. Englewood Cliffs, NJ: Prentice-Hall.

    Google Scholar 

  4. Becketti, S., and C. Morris. (1990). “The Prepayment Experience of FNMA Mortgage-Backed Securities.” Working paper, New York University Salomon Center.

  5. Cox, J.C., J.E. Ingersoll, and S.A. Ross. (1985). “A Theory of the Term Structure of Interest Rates,”Econometrica 53, 385–467.

    Google Scholar 

  6. Cox, D.R., and D. Oakes. (1984).Analysis of Survival Data. New York: Chapman and Hall.

    Google Scholar 

  7. Dunn, K.B., and J.J. McConnell. (1981a). “A Comparison of Alternative Models for Pricing GNMA Mortgage-Backed Securities,”Journal of Finance 36, 471–483.

    Google Scholar 

  8. Dunn, K.B., and J.J. McConnell. (1981b). “Valuation of Mortgage-Backed Securities,”Journal of Finance 36, 599–617.

    Google Scholar 

  9. Dunn, K.B., and C.S. Spatt. (1986). “The Effect of Refinancing Costs and Market Imperfections on the Optimal Call Strategy and the Pricing of Debt Contracts.” Working paper, Carnegie-Mellon University.

  10. Johnston, E., and L. Van Drunen. (1988). “pricing Mortgage Pools with Heterogeneous Mortgagors: Empirical Evidence.” Working paper, University of Utah.

  11. Kau, J.B., D.C. Keenan, W.J. Muller III, and J.F. Epperson. (1992). “A Generalized Valuation Model for Fixed-Rate Residential Mortgages,”Journal of Money, Credit and Banking 24, 279–299.

    Google Scholar 

  12. Kalbfleisch, J.D., and R.L. Prentice. (1980).The Statistical Analysis of Failure Time Data. New york: John Wiley.

    Google Scholar 

  13. McCracken, D., and W. Dorn. (1969).Numerical Methods and FORTRAN Programming. New York; John Wiley.

    Google Scholar 

  14. Pearson, N.D., and T. Sun. (1989). “A Test of the Cos, Ingersoll, Ross Model of the Term Structure of Interest Rates Using the Method of Maximum Likelihood.” Working paper, Massachusetts Institute of Technology.

  15. Richard, S.F., and R. Roll. (1989). “Prepayments on Fixed Rate Mortgage-Backed Securities,”Journal of Portfolio Management 15, 73–82.

    Google Scholar 

  16. Schwartz, E.S., and W.N. Torous. (1989). “Prepayment and the Valuation of Mortgage-Backed Securities,”Journal of Finance 44, 375–392.

    Google Scholar 

  17. Stanton, R.H. (1995). “Rational Prepayment and the Valuation of Mortgage-Backed Securities.”Review of Financial Studies 8, 677–708.

    Google Scholar 

  18. Timmis, G.C. (1985). “Valuation of GNMA Mortgage-Backed Securities with Transaction Costs, Heterogeneous Households and Endogenously Generated Prepayment Rates.” Working paper, Carnegie-Mellon University.

Download references

Author information



Rights and permissions

Reprints and Permissions

About this article

Cite this article

Stanton, R.H. Unobservable heterogeneity and rational learning: Pool-specific versus generic mortgage-backed security prices. J Real Estate Finan Econ 12, 243–263 (1996).

Download citation

Key Words

  • mortgage-backed security
  • prepayment
  • heterogeneity
  • Bayesian updating
  • pool-specific prices