Burnout from pools to loans: Modeling refinancing prepayments as a self-selection process

Gan, Jumwu (2009): Burnout from pools to loans: Modeling refinancing prepayments as a self-selection process.

Abstract

In this paper we present compelling evidence from a detailed analysis of historical prepayment data to demonstrate that a mortgage cohort remembers the level of the previous mortgage rate troughs experienced by the cohort. This is a general property, observed ubiquitously, that inescapably leads to refinancing models with a continuous distribution of refinancing incentive thresholds (elbows). We present such a new refinancing model, derived from the first principle, based on a single assumption that each loan has an incentive threshold above which its borrower will refinance. In this model, the refinancing prepayment of a cohort is a dynamic self-selection process that evolves by itself according to the encountered mortgage rate environment with the cohort concurrently acquiring its memory along the way.

• Item Type: MPRA Paper
• Language: English
• Keywords: Mortgage, Prepayment, refinance, burnout, MBS, duration, convexity
• Subjects: C - Mathematical and Quantitative Methods > C5 - Econometric Modeling > C51 - Model Construction and Estimation; G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing ; Trading Volume ; Bond Interest Rates; C - Mathematical and Quantitative Methods > C5 - Econometric Modeling > C53 - Forecasting and Prediction Methods ; Simulation Methods; G - Financial Economics > G1 - General Financial Markets > G19 - Other; G - Financial Economics > G1 - General Financial Markets > G10 - General; C - Mathematical and Quantitative Methods > C0 - General > C01 - Econometrics

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