Valuation of residential mortgage default and prepayment under stochastic house prices
MetadataShow full item record
This dissertation applies a valuation model for residential mortgages subject to exogenously specified conditional probabilities of prepayment and default to data on subprime and Alt-A adjustable-rate mortgages. In conformity with the doubly stochastic framework, risk-neutral baseline hazard rates of prepayment and default in the model are dependent on stochastically evolving latent factors, driven by Brownian motions. Hazard processes also incorporate observable variables reflecting evolution of interest rates and house prices. The model is estimated on two subsets of the data: one includes early vintages of non-prime ARMs, the other is comprised of 2005 and later vintages. Results of the calibration of the two sets of model parameters to market prices suggest that whatever changes in the unobserved borrowers’ behavior took place in the observation period were relatively soon recognized by the market. Simulations show that for subprime borrowers the effect of house price fluctuations on the probability of default is very significant.