Asia-Pacific Financial Markets

, 11:233 | Cite as

Analyses of Mortgage-Backed Securities Based on Unobservable Prepayment Cost Processes

Article

Abstract

We propose a prepayment model of mortgage based on a structural approach in order to analyze prepayment risk of mortgage-backed securities (MBS). We introduce a continuous process named prepayment cost process. Specifically, each mortgager's prepayment time is defined by the first time when her or his prepayment cost process falls below zero, but prepayment cost processes are supposed to be unobservable in the market. We also introduce a risk unique to each loan pool of mortgages, called a loan pool risk (LPR), and we regard LPR as a systematic risk other than interest rate. Using the model, we discuss the conditional distribution of prepayment times and a risk-neutral valuation of pass-through MBS. It is shown that each mortgager's conditional non-prepayment probability and the posterior distribution of LPR play quite important roles in our study.

Keywords

mortgage-backed securities (MBS) prepayment cost oan pool risk structural approach with incomplete information asymptotic arbitrage-free condition 

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Copyright information

© Springer Science+Business Media, Inc. 2006

Authors and Affiliations

  1. 1.Graduate School of Innovation ManagementTokyo Institute of TechnologyTokyoJapan
  2. 2.MTB Investment Technology Institute Co., Ltd.TokyoJapan
  3. 3.Graduate School of International Corporate StrategyHitotsubashi UniversityTokyoJapan

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