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Article
Publication date: 27 September 2011

Takeaki Kariya, Fumiaki Ushiyama and Stanley R. Pliska

The purpose of this paper is to generalize the one‐factor mortgage‐backed securities (MBS)‐pricing model proposed by Kariya and Kobayashi to a three‐factor model. The…

Abstract

Purpose

The purpose of this paper is to generalize the one‐factor mortgage‐backed securities (MBS)‐pricing model proposed by Kariya and Kobayashi to a three‐factor model. The authors describe prepayment behavior due to refinancing and rising housing prices by discrete‐time, no‐arbitrage pricing theory, making an association between prepayment behavior and cash flow patterns.

Design/methodology/approach

The structure, rationality and potential for practical use of our model is demonstrated by valuing an MBS via Monte Carlo simulation and then conducting a comparative static analysis.

Findings

The proposed model is found to be effective for analysing MBS cash flow patterns, making a decision for bond investments and risk management due to prepayment.

Originality/value

While the one‐factor valuation model Kariya and Kobayashi treated is a basic framework, the generalized model presented in this paper is much more effective for analysing MBS cash flow patterns, making a decision for bond investments and risk management due to prepayment.

Open Access
Article
Publication date: 31 August 2017

Hyeon-Wuk Tae, Ung-Gi Seo, Bong-Gyu Jang, Jun Kim, Jong-Hyuk Roh and Seryoong Ahn

This paper introduces a basic model and an extended model to evaluate the pass-through mortgage-backed securities (MBS) recently issued by Korea Housing Finance…

29

Abstract

This paper introduces a basic model and an extended model to evaluate the pass-through mortgage-backed securities (MBS) recently issued by Korea Housing Finance Corporation. The basic model assumes that the processes of interest rates, prepayment rates, and option-adjusted spreads have simple forms, of which parameters can be easily estimated by the market data available today. This paper presents the pricing formula on the basic model and the demonstrations under the present market data. We also suggest an extended model, a new but complicated model for pricing pass-through MBS, in which the interest rates and prepayment rates follow stochastic processes, and the option-adjusted spread is decomposed into one from refinancing and the other from mortgage turnover. However, since this kind of pass-through MBS has been traded in Korean financial market only recently, the market parameters in the extended model are not able to be estimated properly. We, instead, develop the pricing formula under the extended model and present the process of estimation of the parameters of the model. The participants in Korean MBS market can price the pass-through MBS for now under the basic model with limited set of data available, and later, when the market data is accumulated enough to estimate the parameters properly, they can take advantage of the extended model.

Details

Journal of Derivatives and Quantitative Studies, vol. 25 no. 3
Type: Research Article
ISSN: 2713-6647

Keywords

Book part
Publication date: 9 July 2010

Donald Palmer and Michael Maher

We use normal accident theory to analyze the financial sector, especially that part of the financial sector that processed home mortgages, and the mortgage meltdown. We…

Abstract

We use normal accident theory to analyze the financial sector, especially that part of the financial sector that processed home mortgages, and the mortgage meltdown. We maintain that the financial sector was highly complex and tightly coupled in the years leading up to the mortgage meltdown. And we argue that the meltdown exhibited characteristics of a system or normal accident; the result of a component failure (unusually high mortgage defaults) that, in the context of unique conditions (which included low interest rates and government policy encouraging home loans to less credit-worthy households), resulted in complex and tightly coupled interactions that financial elites and government officials were ill-equipped to control. We also consider the role that agency and wrongdoing played in the design of the financial system and the unfolding of the mortgage meltdown. We conclude that a fundamental restructuring of the financial system, so as to reduce complexity and coupling, is required to avert future similar financial debacles. But we also conclude that such a restructuring faces significant obstacles, given the interests of powerful actors and the difficulties of labeling those responsible for the meltdown as wrongdoers.

Details

Markets on Trial: The Economic Sociology of the U.S. Financial Crisis: Part A
Type: Book
ISBN: 978-0-85724-205-1

Case study
Publication date: 20 January 2017

Craig Furfine

In October 2008, in the midst of a financial crisis, Anthony Keating, investment manager at the Boston private bank Billingsley, Blaylock, and Montgomery, was searching…

Abstract

In October 2008, in the midst of a financial crisis, Anthony Keating, investment manager at the Boston private bank Billingsley, Blaylock, and Montgomery, was searching for an investment strategy to recommend to his high-net-worth clients. Traditional investments in the equity markets were being decimated, and Keating’s clients would be looking to him for ideas. Inspired by the success of Paulson and Co., Keating began to explore the possibility of entering a trade that would profit as homeowners defaulted on their mortgages. The more Keating learned about the trade, the more he realized that he needed to know about mortgage-backed securities and credit default swaps. The case provides instructors with a chance to introduce these financial instruments, while at the same time providing lessons applicable to students interested in value investing or real estate finance.

After reading and analyzing the case, students will be able to:

  • Explain how home mortgages are securitized into financial instruments that are traded in public markets

  • Describe how credit default swaps can be used to speculate on the value of an underlying financial instrument

  • Identify potential mispricing across related financial instruments

  • Understand the potential risks and rewards of various financial investment strategies that look to capitalize on defaults on subprime mortgages

Explain how home mortgages are securitized into financial instruments that are traded in public markets

Describe how credit default swaps can be used to speculate on the value of an underlying financial instrument

Identify potential mispricing across related financial instruments

Understand the potential risks and rewards of various financial investment strategies that look to capitalize on defaults on subprime mortgages

Open Access
Article
Publication date: 30 November 2012

Yun Woo Park and Doo Won Bang

Residential mortgage loans as well as the MBS (mortgage-backed security), which securitizes these loans, are exposed to prepayment risk. We examine the effect of…

4

Abstract

Residential mortgage loans as well as the MBS (mortgage-backed security), which securitizes these loans, are exposed to prepayment risk. We examine the effect of prepayment process on the duration of the CMO (multi-tranche MBS). In particular, we examine the effect of partial pass-through where there is a call limit expressed as a percentage of initial tranche balance. Due to the absence of empirical research on the CMO duration, neither the actual CMO duration nor the determinants of the CMO duration have been reported. Our study reports the actual CMO duration and the determinants of the CMO duration. By showing that the CMO duration is much shorter than the nominal time-to-maturity we point to the need to search for longer duration MBS structures. We find that in both the deterministic and stochastic interest rate environments duration is reduced as prepayment speed rises and duration rises as call limit decreases.

We make contribution to the literature by shedding light on the effect of prepayment and call limit on the duration of multi-tranche MBS. In particular, this research characterizes the impact of the partial pass-through structuring approach on the CMO duration as well as CMO pricing. Finally, it assists CMO investors in better assessing and managing reinvestment risks of pass-through products.

Details

Journal of Derivatives and Quantitative Studies, vol. 20 no. 4
Type: Research Article
ISSN: 2713-6647

Keywords

Article
Publication date: 1 February 2002

PETER RUBINSTEIN, LEO M. TILMAN and ALAN TODD

This article discusses credit migration of diversified loan pool securitizations, as evidenced by the ratings transitions of mortgage‐backed securities (MBS) and…

328

Abstract

This article discusses credit migration of diversified loan pool securitizations, as evidenced by the ratings transitions of mortgage‐backed securities (MBS) and asset‐backed securities (ABS). The authors contrast the ratings (i.e., credit) stability of MBS and ABS relative to ratings migration of general obligation corporate credit. They also use holding period returns to compare the total return portfolios of MBS/ABS to portfolios of senior unsecured corporate obligations.

Details

The Journal of Risk Finance, vol. 3 no. 3
Type: Research Article
ISSN: 1526-5943

Book part
Publication date: 17 December 2003

Joe Peek and James A Wilcox

In recessions, depository institutions accounted for most declines in mortgage flows. Recently, they partially offset their withdrawals from primary markets with…

Abstract

In recessions, depository institutions accounted for most declines in mortgage flows. Recently, they partially offset their withdrawals from primary markets with accumulations of mortgage-backed securities. Increases in direct flows into agency and private pools also countered the declining flows elsewhere. As the less-procyclical secondary mortgage markets grew and matured, they increasingly stabilized mortgage flows. During periods of international financial crises or of domestic economic stress, GSEs may have been particularly effective in stabilizing mortgage markets and moderating business cycles.

Details

Research in Finance
Type: Book
ISBN: 978-1-84950-251-1

Article
Publication date: 1 January 1999

J. PAUL JOSHI and LARRY SWERTLOFF

The advent of derivatives and structured products has coincided with a proliferation of fixed income models used to analyze hedging, pricing, forecasting, and estimation…

Abstract

The advent of derivatives and structured products has coincided with a proliferation of fixed income models used to analyze hedging, pricing, forecasting, and estimation for the term structure of interest rates. This article evaluates five models Ho‐Lee (HL); Black‐Derman‐Toy (BDT); Vasicek; Cox‐Ingersoll‐Ross (CIR); and Heath‐Jarrow‐Morton (HJM) (see Exhibit 1) that are currently used by structured finance practitioners. We suggest which models are most appropriate for assets with different time horizons, interest rate sensitivities and cashflow properties. The authors link model selection to structured financial instruments with the singular focus on the trade‐off between model precision/complexity and calculation costs.

Details

The Journal of Risk Finance, vol. 1 no. 1
Type: Research Article
ISSN: 1526-5943

Abstract

Details

Investment Traps Exposed
Type: Book
ISBN: 978-1-78714-253-4

Article
Publication date: 1 March 1999

Robert S. Seiler

There are striking similarities between publicly-held government-sponsored enterprises (GSEs) such as Fannie Mae and Freddie Mac and investor-owned public utilities. Each…

Abstract

There are striking similarities between publicly-held government-sponsored enterprises (GSEs) such as Fannie Mae and Freddie Mac and investor-owned public utilities. Each firm enjoys large scale economies that give a significant competitive advantage over other companies, possesses a dominant market position that it may be able to exploit to earn profits above competitive levels, and has a strong incentive to enter new markets when the life cycle of its core markets constrain its ability to increase profits. The recent behavior of Fannie Mae and Freddie Mac indicates that the government must impose more stringent economic regulation on those GSEs in order to be sure that they achieve their public purposes.

Details

Journal of Public Budgeting, Accounting & Financial Management, vol. 11 no. 1
Type: Research Article
ISSN: 1096-3367

1 – 10 of 179