Appraisal of Multi-Layered MBS with Real Option Analysis: Focused on Prepayment Risk

Abstract

This paper shows a appraising model based on real option theory with CMOs, Multi-Layered MBS, that involves prepayment risk when housing prices fluctuate with uncertainty, analyzes and considers the results, and proposes related implications. And, the result is as follows. 1) As the strike price(the sale price of the house) of an prepayment option increases, the occurrence of the prepayment delays and the value of the prepayment risk reduces. 2) As the volatility of housing prices increase, the prepayment period advances, and the value of the prepayment risk increases. 3) The lower the loan interest rate, the lower the prepayment risk, because this paper assumes that prepayment is caused by housing prices’ uncertainty. Finally, the issuer of MBS needs to set up a strategy to reasonably respond to the prepayment risk within the level tolerated by the capital market by adjusting the CMOs’ price based on changes in housing prices and market interest rates.