# Default and prepayment risk management using option based mortgage contract pricing method

2018-09-11
Yılmaz, Bilgi
Kestel, Sevtap Ayşe
Mortgage is an important factor in real estate business. The deals done based on the long-term investments, consider real estates as an option to secure the future investments, such as in life insurance, pension savings and reverse mortgage agreements. This study aims pricing a mortgage contract based on the modeling on a financial instrument. It consists of two main parts: (i) The option based mortgage contract pricing is introduced using a two-state bivariate diffusion stochastic model which has two important advantages. First, within this framework, PDEs and finite difference methods are available for the computation of the mortgage contract prices. Second, it allows a simple description of the correlation between volatility movements and returns, which is parameterized by the correlation coefficient of the two Wiener processes. (ii) Exploring the hedging coefficients of the mortgage default and prepayment options, which are embedded into mortgage contracts based on the change in spot rate and underlying house price to manage the default and prepayment risk. Having these two aims, we use the finite-dimensional Malliavin calculus, since the distribution of both options are unknown, their payoffs are non-differentiable and more importantly, numerical solution of mortgage PDEs may not be required. Naturally, we obtain the hedging coefficients as a product of option’s payoff and an independent weight, which permit us to derive estimates by running a Monte Carlo (MC) algorithm. The simulations reveal that the default and prepayment options are both more sensitive to changes in spot rate than changes in the underlying house prices
4 th European Actuarial Journal Conference (2018)

# Suggestions

 Computation of Hedging Coefficients for Mortgage Default and Prepayment Options: Malliavin Calculus Approach YILMAZ, BİLGİ; Kestel, Sevtap Ayşe (2019-11-01) This study explores the hedging coefficients of the financial options to default and to prepay embedded into mortgage contracts based on the change in spot rate, underlying house price and its volatility. In the computations, the finite-dimensional Malliavin calculus is applied since the distribution of both options is unknown and their payoffs are non-differentiable. Naturally, the hedging coefficients are obtained as a product of option's payoff and an independent weight, which permits the user to derive ...
 Default risk of wage-indexed payment mortgage in Turkey Erol, Işıl; Patel, K (2005-09-01) This paper analyses default risk of wage-indexed payment mortgage (WIPM) in Turkey in comparison with other standard mortgage contracts originated in high inflationary economies. Emlak Bank launched WIPM linked to Civil Service employees' wage (CSW) index during high inflationary period of late 1990s. Concurrently, the government introduced a policy linking CSW index to semi-annual expected rate of inflation in an attempt to facilitate housing finance for the fastest growing sector of the population. We fin...
 Hava Aracı İpoteği Kurtuluş, Dilek Funda (2017-01-01) The main type of movable mortgage is a mandatory delivery mortgage. Other types of movable mortgage appear as exceptions to the mandatory mortgage. In order to prevent some of the inconveniences that are due to the delivery, the movable mortgage that does not require delivery has been created. These include animal mortgage, mining mortgage, movable property mortgage, ship mortgage and aircraft mortgage. These types of mortgages are referred to as registered movable mortgages. In the registered movable mort...
 Real estate appraisal methods and their application in Ankara Bulut, Zeynep; Türel, Ali; Department of City and Regional Planning (2011) Real estate is one of the reliable and important investment types for individuals and institutions. Interest in the price appraisal of real estate has increased with rapid development of real estate sector and its legal infrastructure in recent years. Conducting planned urbanization, choosing settlement areas and estimating their inner or outer transport costs, improving capital markets transparency, and reliability require a reliable price valuation of real estate assets. Appraisal in real estate is also i...
 Option pricing in interest rate derivatives Küçüksaraç, Doruk; Danışoğlu, Seza; Department of Financial Mathematics (2020) The valuation of interest rate derivatives and embedded options in fixed-income securities is crucial for market practitioners. Although there have been many models to price interest rate derivatives, the inconsistency across the assumptions of the models creates difficulty in aggregating interest rate exposures. Besides, the models tend to be applicable to specific cases. In this regard, adaptation of a general methodology to price all interest rate derivatives without making additional assumptions has cri...
Citation Formats
B. Yılmaz and S. A. Kestel, “Default and prepayment risk management using option based mortgage contract pricing method,” presented at the 4 th European Actuarial Journal Conference (2018), Leuven, Belgium, 2018, Accessed: 00, 2021. [Online]. Available: https://kuleuvencongres.be/eaj2018/documents/eaj-2018-program-book.