Woodhead Behavior & The Pricing Of Residential Mortgages
- Topics:
- Market Studies
- Tags:
- Behavior,
- Capital Structures,
- Finance,
- Marketing,
- Mortgages,
- Pricing,
- Pricing Strategy,
- University Of Southern California
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Overview: Mortgage terminations arise because borrowers exercise options. This paper investigates the apparently irrational behavior of those borrowers who do not terminate their mortgages even when the exercise value of the option is deeply in the money.The article develops an option-based empirical model to analyze this phenomenon -- the behavior of irrational “woodheads.” Of course we do not observe “woodheads” explicitly in any body of data. Instead, an analysis of the correlates of unobserved heterogeneity within a large sample of mortgage holders. The article develops an error correction maximum likelihood (ECML) estimator using martingale transforms to estimate the competing risks of mortgage prepayment and default, recognizing unobserved heterogeneity, which is due in part to the behavior of “woodheads.” The extended model is clearly superior to alternatives on statistical grounds. We then analyze the economic implications of this more powerful model. The article analyzes the predictions of the model for the valuation and pricing of mortgage pools and mortgage-backed securities.
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Format: PDF | Size: 282KB | Date: Dec 2002 | Pages: 32
