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A Lattice Approach to Pricing Fixed‐Rate Mortgages with Default and Prepayment Options
Author(s) -
Leung Wai K.,
Sirmans C. F.
Publication year - 1990
Publication title -
real estate economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.064
H-Index - 61
eISSN - 1540-6229
pISSN - 1080-8620
DOI - 10.1111/1540-6229.00511
Subject(s) - prepayment of loan , economics , econometrics , debt , database transaction , interest rate , financial economics , actuarial science , computer science , monetary economics , finance , programming language
Existing models on the pricing of default and prepayment options in fixed‐rate mortgages either use numerical methds or they do not consider refinancing or other transaction costs involved in default and prepayment. We provide in this paper an application of the Boyle [1] lattice model to price secured debt with two risky assets. This model is simple, efficient and capable of considering the major types of transaction costs involved in prepayment and default. Using our model, we estimate the option values under a range of assumptions about the underlying parameters. We also provide some comparisons of the lattice model estimates to other models in the literature.