Abstract
Prepayment models have come to be widely used in the mortgage market. Effective models are based on fundamental relationships that are likely to persist over time, but allow time-varying values of key inputs in order to capture environmental changes over time. The authors explain the major causes of prepayments, and describe how the modeling framework deals with them through turnover, refinancing, default, and curtailment sub-models. They applied the model to five applications covering a range of borrower demographics and mortgage terms, including home equity loans, hybrid ARMs, and prepayment penalty mortgages. A “user9s guide” cautions readers about the conditional nature of projections and prepayment model error.
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