Valuation of Mortgage-Backed Securities and Mortgage Derivatives: A Closed-Form Approximation

In this paper we develop a closed-form and thus computationally highly efficient formula to approximate the value of fixed-rate MBS. Our modelling framework is based on reduced-form and prepayment-risk neutral valuation techniques and offers two major extensions compared to existing closed-form approximation approaches: We include a stochastic baseline prepayment factor into our model and we are able to capture the usual S-curve shape of the refinancing incentive by a piecewise linear approximation. We apply our model to GNMA pass-through securities and test it on a 10-year sample of monthly GNMA MBS market prices for a wide range of coupons.     «

In this paper we develop a closed-form and thus computationally highly efficient formula to approximate the value of fixed-rate MBS. Our modelling framework is based on reduced-form and prepayment-risk neutral valuation techniques and offers two major extensions compared to existing closed-form approximation approaches: We include a stochastic baseline prepayment factor into our model and we are able to capture the usual S-curve shape of the refinancing incentive by a piecewise linear approximat...     »