Default and prepayment options pricing and default probability valuation under VG model

Date

2022-01-01

Author

Yilmaz, Bilgi
Hekimoglu, A. Alper
Kestel, Sevtap Ayşe

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This work is licensed under a Creative Commons Attribution-NonCommercial-NoDerivatives 4.0 International License.

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In this paper, a new approach, the Variance Gamma (VG) model, which is used to capture unexpected shocks (e.g., Covid-19) in housing markets, is proposed to contribute to the standard option-based mortgage valuation methods. Based on the VG model, the closed-form solutions are performed for pricing mortgage default and prepayment options. It solves the options pricing equations explicitly and illustrates numerical results for both mortgage default and prepayment options' prices. Furthermore, the study enables researchers to monitor the default probability of mortgagors. Analyzing the effect of risks on default and prepayment options using simulations shows that the VG model captures the systematic and systemic (idiosyncratic) risks of default and prepayment options prices with closed-form solutions and computes the mortgage default probabilities. Therefore, it allows lenders a more advanced decision process compared to the standard option-based mortgage valuation method. (C) 2021 Elsevier B.V. All rights reserved.

URI

https://hdl.handle.net/11511/91926

Journal

JOURNAL OF COMPUTATIONAL AND APPLIED MATHEMATICS

DOI

https://doi.org/10.1016/j.cam.2021.113724

Collections

Graduate School of Applied Mathematics, Article

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Citation Formats

B. Yilmaz, A. A. Hekimoglu, and S. A. Kestel, “Default and prepayment options pricing and default probability valuation under VG model,” JOURNAL OF COMPUTATIONAL AND APPLIED MATHEMATICS, vol. 399, pp. 0–0, 2022, Accessed: 00, 2021. [Online]. Available: https://hdl.handle.net/11511/91926.