A note on bias resulting from imposing expedient conditions on mortgage valuation models

Abstract

This study seeks to understand how mortage valuation behaves under the alternative simplifications of nonamortization, continual interest payments, continuously exercisable default, and a prepayment option that may be exercised only periodically. The goal is to compare the effect of these differing simplifications against exact results for the standard mortgage offered in the market place. The comparison provides researchers with evidence in support of making such expedient choices in modeling. Except for amortization, there is little loss in precision from choosing the less contractually accurate mortgage representations. © 1992.