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Assessing mortgage servicing rights using a reduced-form model: Considering the effects of interest rate risks, prepayment and default risks, and random state variables

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  • Chiang, Shu Ling
  • Yang, Tyler T.
  • Tsai, Ming Shann
Abstract
Assessing an MSR's value is difficult in practice because it involves various revenues and costs that are influenced by both the stochastic property of interest rates and the likelihood of prepayment and default. This paper derives a pricing formula using a reduced-form model in order to appraise the MSR's breakeven servicing fee. Numerical examples are given to demonstrate the applications of this reduced-form pricing formula in deriving the breakeven servicing fee and analyzing profits of an MSR. We also provide numerical sensitivity analysis results for operational and state variables to show how the breakeven servicing fee changes with respect to various operational conditions and economic circumstances. Results reveal that changes in the breakeven servicing fee depend mainly on direct servicing costs, the initial interest rate, and the volatility of the interest rate. Our model can assist financial institutions and regulators in evaluating fair servicing fees and in turn improve the management of the various risks of an MSR in response to changing economic conditions and operating costs.

Suggested Citation

  • Chiang, Shu Ling & Yang, Tyler T. & Tsai, Ming Shann, 2016. "Assessing mortgage servicing rights using a reduced-form model: Considering the effects of interest rate risks, prepayment and default risks, and random state variables," Journal of Housing Economics, Elsevier, vol. 32(C), pages 29-46.
    • Handle: RePEc:eee:jhouse:v:32:y:2016:i:c:p:29-46
    DOI: 10.1016/j.jhe.2016.04.001
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    More about this item

    Keywords

    Mortgage servicing rights; Reduced-form model; Breakeven servicing fee; Numerical analyses;
    All these keywords.

    JEL classification:

    • C10 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - General
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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