Prepayment Modeling and Valuation of Dutch Mortgages

Abstract

The Dutch mortgage-backed securities (MBS) market is the benchmark euro-denominated MBS market. It is also one of the few European markets where mortgage coupons are fixed for extended periods of time, so prepayment risk is an important factor. A general prepayment modeling framework is used to develop a model for Dutch MBS, using historical speeds on Dutch mortgage deals. A key issue for the refinancing component is reconciliation of the fast speeds observed in periods of low rates, such as in 1999, with the presence of severe prepayment penalties, which in theory should discourage refinancings. An innovative approach models the refinancing incentive not just in terms of the current level of rates, but also taking into account the relationship of rates to the past. An option-adjusted spread analysis of the fixed-rate A2 class of the Match 2002–1 MBS deal provides an illustration.