A Freer Markets Approach To Fixing The Housing Market

The unprecedented level of government intervention in recent financial markets has mainly ignored the root cause of the financial institution balance sheet problem: housing prices. Rather than apply taxpayer dollars to the symptoms (i.e. buying securities), policies directed at reducing inefficiencies and poor incentives in the housing market will help fix the system from the bottom up and motivate the substantial capital waiting in the wings to buy distressed housing assets. This paper proposes eliminating some of these frictions and inducing positive optionality in the housing market to better incentivize fresh housing investment at a much lower cost than many of the alternative plans included in the $700+ billion congressional and administrative plans thus far

Improving Parametric Mortgage Prepayment Models with Non-parametric Kernel Regression

Developing a good prepayment model is a central task in the valuation of mortgages and mortgage-backed securities but conventional parametric models often have bad out-of-sample predictive ability. A likely explanation is the highly non-linear nature of the prepayment function. Non-parametric techniques are much better at detecting non-linearity and multivariate interaction. This article discusses how non-parametric kernel regression may be applied to loan level event histories to produce a better parametric model. By utilizing a parsimonious specification, a model can be produced that practitioners can use in valuation routines based on Monte Carlo interest rate simulation.