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Behavioral Value Adjustments for Mortgage Valuation

In: Innovations in Insurance, Risk- and Asset Management

Author

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  • M. Bissiri
  • R. Cogo

Abstract

Behavioral risk affects the pricing of assets and liabilities with embedded pre-payment/extension options whenever the option holder does not act purely on the strength of financial convenience but follows an uncertain and sub-optimal exercise strategy, if seen from the viewpoint of the option seller. Such behavior is particularly relevant for mortgage valuation, since mortgage prepayments are clearly influenced by exogenous and individual factors besides financial reasons. In this paper we apply the general framework, proposed by Bissiri and Cogo, for modeling behavioral risk to the particular case of the valuation of a fixed-rate mortgage portfolio. We also extend the formulas by considering a pool of heterogeneous mortgagors, leading to the introduction of specific behavioral risk adjustments (βVA) in the pricing formulas.

Suggested Citation

  • M. Bissiri & R. Cogo, 2018. "Behavioral Value Adjustments for Mortgage Valuation," World Scientific Book Chapters, in: Kathrin Glau & Daniël Linders & Aleksey Min & Matthias Scherer & Lorenz Schneider & Rudi Zagst (ed.), Innovations in Insurance, Risk- and Asset Management, chapter 1, pages 3-25, World Scientific Publishing Co. Pte. Ltd..
    • Handle: RePEc:wsi:wschap:9789813272569_0001
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    Keywords

    Insurance; Actuarial Science; Risk Measure; Reinsurance; Copula; Replicating Portfolio; Bayesian Finance; Risk Classification; Stochastic Dominance; Dynamic Hedging; Autoregressive Hidden Markov Models; Exchange-Traded Funds; Uncertainty Quantification; Fixed Income; Stochastic Processes for Finance;
    All these keywords.

    JEL classification:

    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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