Originating long-term fixed-rate mortgages in developing economies: new evidence from turkey

This paper intends to analyze the recent developments to introduce and integrate mortgage markets into capital markets of Turkey. The Capital Market Board has recently prepared a legal framework not only for a proper mortgage system, but also for the eventual securitization of these mortgages. Turkish banks started to contract, for the first time ever, longterm fixed rate mortgages. The paper uses traditional optionpricing model to evaluate the current 10year fixed rate mortgage (FRM) contracts with embedded default and prepayment options in Turkey. Our study is the very first attempt to use an option pricing model to price the FRM contracts in an emerging economy with its different and unique dynamics. Our findings show that, in 2007 almost every bank, except for Is Bank, offered mortgage interest rates that were significantly below the equilibrium coupon rates, involving arbitrage profit for the borrowers. We also conclude that even if the prevailing mortgage interest rates are below the equilibrium rates, these rates are extremely high for establishing a wellfunctioning primary mortgage market in any economy. Finally, the effects of the global financial crisis are started to be felt in Turkish mortgage market as the banks have increased their mortgage coupon rates and shortened the contract maturities drastically over a very short time period, from September 2007 to November 2008.

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FRMs emerging economies option pricing model ,

default option prepayment option ,

Turkish mortgage market explicit finite difference method ,