THE VALUE OF SERVICING FIXED-RATE AND ADJUSTABLE-RATE MORTGAGE LOANS IN A STOCHASTIC ECONOMY (CONTINUOUS-TIME, LOAN ADMINISTRATION)
Abstract
This dissertation is an investigation into the determinants of the value or profitability of servicing fixed-rate mortgage loans (FRMs) and adjustable-rate mortgage loans (ARMs). Mortgage loan servicing is becoming an increasingly important and autonomous component of financial intermediary operations. Furthermore, the advent of ARMs also necessitates rethinking the important determinants of servicing value. The value of mortgage loan servicing is influenced by several important interrelated forms of uncertainty. The contract life is uncertain because the mortgagor has the option to prepay or default on the loan at any time prior to maturity. The probability of mortgage prepayment is in part determined by the dynamics of both the stochastic real interest rate and inflation rate over the life of the mortgage. The loan servicer is also faced with uncertain nominal servicing costs due to the possibility of future inflation. To facilitate the mortgage servicing analysis, a theoretical servicing valuation model is developed. The model represents a contribution to the literature which seeks to apply modern intertemporal asset pricing models to the problem of project evaluation. The model developed in this dissertation incorporates the interactions between: a stochastic real interest rate and commodity price level, mortgage prepayments that are endogenously determined by the optimal mortgagor refinancing decision, the amount of coupon rate adjustability allowed by the mortgage contract, and nominal servicing costs that are affected by the commodity price level over the life of the servicing contract. The servicing valuation model predicts that the most important variable to impact on mortgage servicing value is the uncertain mortgage life. Furthermore, since fixed-rate mortgagors have quite different refinancing prepayment incentives than do adjustable-rate mortgagors, the value of FRM servicing and the value of ARM servicing are differentially affected by changes in the interest rate dynamics and origination coupon rates. The implication is that financial intermediaries must account for the interaction between the real interest rate and inflation rate dynamics and the mortgage loan contract when assessing the value or profitability of their mortgage servicing activities.
Degree
Ph.D.
Subject Area
Finance
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