Mortgage valuation: a quasi-closed form solution

Viegas, Cristina; Azevedo Pereira, José

http://hdl.handle.net/10400.1/4825

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Authors

Viegas, Cristina

Azevedo Pereira, José

Abstract(s)

The main objective of this study consists in developing a quasi-analytical solution for the valuation of commercial mortgages. We consider the existence of a single source of risk - the risk of defaulting on a mortgage - and therefore, the existence of a single state variable - the value of the mortgaged property. The value of the mortgage corresponds to the present value of the future payments on the loan, minus the value of the embedded American default option. The major difficulty in designing such a model consists in calculating the value of this option, since for that purpose it is necessary to determine the lowest property price below which it must be immediately exercised, i.e. the critical value of the property.