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A three‐factor valuation model for mortgage‐backed securities (MBS)

A three‐factor valuation model for mortgage‐backed securities (MBS) Purpose – The purpose of this paper is to generalize the one‐factor mortgage‐backed securities (MBS)‐pricing model proposed by Kariya and Kobayashi to a three‐factor model. The authors describe prepayment behavior due to refinancing and rising housing prices by discrete‐time, no‐arbitrage pricing theory, making an association between prepayment behavior and cash flow patterns. Design/methodology/approach – The structure, rationality and potential for practical use of our model is demonstrated by valuing an MBS via Monte Carlo simulation and then conducting a comparative static analysis. Findings – The proposed model is found to be effective for analysing MBS cash flow patterns, making a decision for bond investments and risk management due to prepayment. Originality/value – While the one‐factor valuation model Kariya and Kobayashi treated is a basic framework, the generalized model presented in this paper is much more effective for analysing MBS cash flow patterns, making a decision for bond investments and risk management due to prepayment. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Managerial Finance Emerald Publishing

A three‐factor valuation model for mortgage‐backed securities (MBS)

Takeaki Kariya; Fumiaki Ushiyama; Stanley R. Pliska
Managerial Finance , Volume 37 (11): 20 – Sep 27, 2011
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References (24)

Publisher
Emerald Publishing
Copyright
Copyright © 2011 Emerald Group Publishing Limited. All rights reserved.
ISSN
0307-4358
DOI
10.1108/03074351111167947
Publisher site
See Article on Publisher Site

Abstract

Purpose – The purpose of this paper is to generalize the one‐factor mortgage‐backed securities (MBS)‐pricing model proposed by Kariya and Kobayashi to a three‐factor model. The authors describe prepayment behavior due to refinancing and rising housing prices by discrete‐time, no‐arbitrage pricing theory, making an association between prepayment behavior and cash flow patterns. Design/methodology/approach – The structure, rationality and potential for practical use of our model is demonstrated by valuing an MBS via Monte Carlo simulation and then conducting a comparative static analysis. Findings – The proposed model is found to be effective for analysing MBS cash flow patterns, making a decision for bond investments and risk management due to prepayment. Originality/value – While the one‐factor valuation model Kariya and Kobayashi treated is a basic framework, the generalized model presented in this paper is much more effective for analysing MBS cash flow patterns, making a decision for bond investments and risk management due to prepayment.

Journal

Managerial Finance – Emerald Publishing

Published: Sep 27, 2011

Keywords: Securities; Pricing; Cash flow; Mortgage‐backed securities (MBS); Discrete time three‐factor model; Refinance; Prepayment behaviour; Burnout‐effect

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