PRICING AND HEDGING PREPAYMENT RISK IN A MORTGAGE PORTFOLIO

Understanding mortgage prepayment is crucial for any financial institution providing mortgages, and it important hedging the risk resulting from such unexpected cash flows. Here, in setting of a Dutch provider, we propose to include nonlinear instruments hedge portfolio when dealing with mortgages option prepay part notional early. Based on assumption that there correlation between interest rates market, model proposed which based specific refinancing incentive. The linear risks are addressed by set tradeable static strategy. We will show stochastic unveils embedded option. calibration incentive data more than thirty million observations, functional form prepayments defined, accurately reflects borrowers’ behavior. compare this fully rational model, where assumed be exercised rationally.