Bond - Callable Mortgage Bond

Specialeforsvar ved Nicolai Bjerre Pedersen og Silas Furu Friby

Titel : Bond- Callable Mortgage Bond

Resume: The fair price of a callable mortgage bond is modelled from an arbitrage-free pricing point of view. The pricing of callable bonds evolves around two aspects of complexity: (1) modelling the dynamic behavior of market interest rates, and (2) modelling the prepayment behaviour of mortgagors. The latter is the primary focus of this thesis. For that reason the short rate is assumed to follow the tractable Vasicek model. Nonetheless it is explained how more sophisticated term structure models can be incorporated through the Cheyette model. The central part of the thesis consists of a thorough investigation of two different prepayment models, one originating from the academic world and the other from Danske Bank, i.e. the 'real' world. The models are compared on their ability to predict prepayment behaviour, fit observed market quotes and match the rate sensitivity induced by the market. It is concluded that the model originating from the academic world is preferable in various aspects. However, there is always room for improvement. Therefore possible ways in which one may extend the models are discussed. All prices are derived using finite difference methods. 

Vejledere:  Rolf Poulsen, Jacob Nielsen, Danske Bank
Censor:      Bjarne Astrup Jensen, CBS