Prepayment Risk

[arpitpmehta]

Hi David,

I am studying prepayment risk on housing loan with focus on impact on liquidity gaps of a bank. I wish to apply behavioral analysis of
1. when prepayment would happen (eg. 20% in year 5, 30% in year 10 and 50% in year 15) for a fixed tenor year loan (say 30 years) and
2. how much loans get prepaid (e.g. 4% of 30 year loan portolio)
3. why prepayment happened (due to interest rate change by this bank or due to other reasons).

Can you explain me how to measure point number 3?

 

[David Harper CFA FRM]

Hi @arpitpmehta please see (eg)

• https://forum.bionicturtle.com/threads/frm-fun-24-mbs-prepayments-p1-or-p2.6300/#post-20086
  
• https://forum.bionicturtle.com/thre...ces-and-causes-of-prepayment.5454/#post-15275

For good discussion I recommend

• Chapter 8 (previously FRM assigned, and still one of my best references on MBS) of Veronesi's excllent Fixed Income https://forum.bionicturtle.com/resources/veronesi-fixed-income-securities.104/ Here is an XLS which replicates some of his exhibits, and utilizes SMM in a cash flow analysis https://www.dropbox.com/s/gy2vsj4aj7rgvyy/t6.612 T5.30.8_Veronesi_MBS.xlsx?dl=0
• Fabozzi's Handbook of Mortgage-backed Securities goes further (http://amzn.to/2rMsqmN). I hope that's a helpful start!

 

[arpitpmehta]

Hi David,

Though your posts above helps in understanding MBS, I wish to quantify very basic aspects: -

I wish to measure how drop in loan interest rates leads to prepayment. I will ultimately use this as behavioral analysis for determining prepayment percentage and tenor and use it for ALM purpose for strucural liquidity gap analysis.

Please help in how to quantify the same.

 

[David Harper CFA FRM]

Hi @arpitpmehta The new edition of Fabozzi's Handbook of Mortgage-backed securities (7th edition), in particular, Part IV (Valuation and Prepayment Modeling), contains some expert discussion on this. Thanks,

 

[bpdulog]

Hi David,

I am studying prepayment risk on housing loan with focus on impact on liquidity gaps of a bank. I wish to apply behavioral analysis of
1. when prepayment would happen (eg. 20% in year 5, 30% in year 10 and 50% in year 15) for a fixed tenor year loan (say 30 years) and
2. how much loans get prepaid (e.g. 4% of 30 year loan portolio)
3. why prepayment happened (due to interest rate change by this bank or due to other reasons).

Can you explain me how to measure point number 3?

Your point 3 is very difficult to quantify, because it is very idiosyncratic. The prepayment can either be due to market factors like interest rates or life events such as job relocation, I am not even sure if banks record this kind of data.