Interest rate risk hedging for due-on-sale mortgages with early termination

Interest rate risk hedging for due-on-sale mortgages with early termination

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Article ID: iaor201522889
Volume: 10
Issue: 2
Start Page Number: 133
End Page Number: 142
Publication Date: Jun 1987
Journal: Journal of Financial Research
Authors: ,
Keywords: finance & banking
Abstract:

The impact of random early termination on the interest rate elasticity and the related implications of hedging a mortgage security are examined. The common approach to computing duration using average mortgage life is shown to be biased and insufficient. Because the prepayment distributions of mortgages tend to have wide dispersions, substantial errors result from using average mortgage life. These results are also applicable to other financial obligations subject to prepayment.

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