Working Paper: NBER ID: w2290
Authors: Patric H. Hendershott; Robert Van Order
Abstract: Mortgages, like all debt securities, can be viewed as risk-free assets plus or minus contingent claims that can be usefully viewed as options. The most important options are: prepayment, which is a call option giving the borrower the right to buy back the mortgage at par, and default, which is a put option giving the borrower the right to sell the house in exchange for the mortgage. This paper reviews and interprets the large and growing body of literature that applies recent results of option pricing models to mortgages. We also provide a critique of the models and suggest directions for future research.
Keywords: mortgages; pricing; option pricing models; financial markets
JEL Codes: G21; D81
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Ability to prepay (G51) | Valuation of the mortgage (G21) |
| Introduction of mortgage default (G21) | Valuation of the mortgage (G21) |
| Expected yield on the mortgage (G21) | Risk-free rate + Risk premium (G12) |
| Transaction costs (D23) | Pricing outcomes (L11) |
| Borrower and lender characteristics (G51) | Pricing outcomes (L11) |