Pricing Mortgage Assets

Abstract

Turkey, being one of the large economies of the world and an outstanding example among its emerging market counterparts, still lacks a robust mortgage lending system. Lenders tend to keep the home loans on their balance sheets. Without proper vehicles for securitization, the growing size of these assets will continue to be an impediment towards lowering the costs and expanding the primary market volume. The to-be-instated mortgage regulation will provide the lenders with necessary tools to securitize. However, the issuers will have to deal with certain complexities of pricing a first issuance in Turkey. There are certain determinants of pricing an issuance. Among them, prepayment behavior of the consumers has crucial importance. Once the prepayment behavior is estimated and modeled into a mathematical function, the deviation in cash flow expectancy will be minimized and hence, the mortgage backed securities could be priced in a healthier fashion. This study illustrates a prepayment modeling method utilizing binomial expansion for option pricing. It is concluded that, there should be special emphasis placed on modeling prepayment behavior of Turkish borrowers to allow for any secondary market issuance.