Housing-price cycles and prepayment rates of US mortgage pools

Empirical mortgage prepayment models generally have trouble explaining diff erences in mortgage-prepayment speeds among pools with similar interest rat es on the underlying mortgages. In this article, we model some of the sourc es of termination heterogeneity across mortgage pools, particularly the rol e of regional variations in housing prices in generating atypical prepaymen t speeds. Using a sample of Freddie Mac mortgage pools from 1991 to 1998, w e compare two classes of empirical models: a rational option-pricing model using a backward-solving pricing algorithm and an empirical hazard model. I n both empirical estimation strategies, we find evidence that differences i n house-price dynamics across regions are an important source of between-po ol heterogeneity. This finding is then shown to be robust to alternative wa ys of parameterizing pool heterogeneity in mortgage termination models.