Endogenous current coupons

Abstract

We consider the problem of identifying current coupons for agency-backed to-be-announced pools of residential mortgages. Such coupons, or mortgage origination rates, ensure par-valued pools. In a doubly stochastic reduced form model which allows prepayment intensities to depend upon both current and origination mortgage rates, as well as underlying investment factors, we identify the current coupon as a solution to a degenerate elliptic, nonlinear fixed point problem. Using Schaefer’s theorem, we prove existence of a current coupon. We also provide an explicit approximation to the fixed point, valid for compact perturbations off a baseline factor-based intensity model. A numerical example is provided which shows that the approximation performs well in estimating the current coupon.