Closed-form mortgage pricing formula with outstanding principal as prepayment value

Yi Cheng Tsai*, Zheng Hui Chen, Jan Ming Ho, Ming-Yang Kao, Chin Laung Lei, Szu Lang Liao

*Corresponding author for this work

Research output: Chapter in Book/Report/Conference proceedingConference contribution

Abstract

This study considers all the possible actions a borrower may have, i.e., to default, to prepay, and to maintain the mortgage, during mortgage horizon. Then, we provide an effective and accurate pricing formula, which not only considers the effect that default might affect the mortgage value, but also more accurately explores the impact due to prepayment risk. In our model, we define prepayment value of the mortgage as the amount of outstanding principle. In contrast, previous literature defines prepayment value as a constant proportion of maintaining value of the mortgage. Finally, based on closed-form pricing formula, we analyze the yield, duration and convexity of risky mortgage loan, providing a better framework for risk management.

Original languageEnglish (US)
Title of host publication2012 IEEE Conference on Computational Intelligence for Financial Engineering and Economics, CIFEr 2012 - Proceedings
Pages100-106
Number of pages7
DOIs
StatePublished - Nov 27 2012
Event2012 IEEE Conference on Computational Intelligence for Financial Engineering and Economics, CIFEr 2012 - New York City, NY, United States
Duration: Mar 29 2012Mar 30 2012

Publication series

Name2012 IEEE Conference on Computational Intelligence for Financial Engineering and Economics, CIFEr 2012 - Proceedings

Other

Other2012 IEEE Conference on Computational Intelligence for Financial Engineering and Economics, CIFEr 2012
CountryUnited States
CityNew York City, NY
Period3/29/123/30/12

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ASJC Scopus subject areas

  • Artificial Intelligence
  • Finance

Cite this

Tsai, Y. C., Chen, Z. H., Ho, J. M., Kao, M-Y., Lei, C. L., & Liao, S. L. (2012). Closed-form mortgage pricing formula with outstanding principal as prepayment value. In 2012 IEEE Conference on Computational Intelligence for Financial Engineering and Economics, CIFEr 2012 - Proceedings (pp. 100-106). [6327778] (2012 IEEE Conference on Computational Intelligence for Financial Engineering and Economics, CIFEr 2012 - Proceedings). https://doi.org/10.1109/CIFEr.2012.6327778