Abstract: One class of approaches to prepayment modeling in the literature assumes that refinancing rates are governed by the borrowers' liability in a fashion similar to American option exercise policy. However, a straightforward arbitrage argument is not applicable in this case since residential borrowers do not trade their liabilities. In this paper, we introduce a new approach to model the prepayment which is built on an idea of lender's arbitrage. The novelty of this approach, in particular, is that it shows that the burn-out effect has a direct influence on the borrowers' refinancing incentives.
Publication Year: 2007
Publication Date: 2007-09-17
Language: en
Type: article
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