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Mortgage Terminations: The Role of Conditional Volatility

Author

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  • David Harrison
  • Thomas Noordewier
  • K. Ramagopal

Abstract

This article is the winner of the Real Estate Finance manuscript prize (sponsored by Fannie Mae Foundation) presented at the 2001 American Real Estate Society Annual Meeting.Studies of mortgage termination decisions typically rely on a competing risks framework comparing defaults and prepayments. While useful tools have been developed to approximate the values of these competing default and prepayment options, the available metrics do not adequately account for the role of the conditional volatility of interest rates and housing prices in option valuation. Using a sample of 1,428 mortgage loan payment histories, this study finds that exponential GARCH estimates of the conditional volatility of housing prices and interest rates influence mortgage termination decisions in a predictable manner. Specifically, increased housing price volatility is shown to enhance default option values, while increased interest rate volatility is shown to enhance prepayment option values. Therefore, it would appear that conditional volatility represents a more refined input into the competing risks option framework.

Suggested Citation

  • David Harrison & Thomas Noordewier & K. Ramagopal, 2002. "Mortgage Terminations: The Role of Conditional Volatility," Journal of Real Estate Research, Taylor & Francis Journals, vol. 23(1-2), pages 89-110, January.
    • Handle: RePEc:taf:rjerxx:v:23:y:2002:i:1-2:p:89-110
    DOI: 10.1080/10835547.2002.12091074
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