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Unlike most residential mortgagebacked securities, Farmer Mac agricultural mortgagebacked securities AMBS have prepayment penalties. To quantify the impact of prepayment penalties on the cost of funding loans, prepayment behavior, and AMBS value, an analytic AMBS model is developed and numerically solved using pathwise simulation and dynamic programming. The results suggest prepayment penalties currently being used by Farmer Mac reduce AMBS yields considerably relative to not charging prepayment penalties. Presumably, lower yielding AMBS imply more competitive loan pricing. Even with prepayment penalties in place, however, it can be advantageous for profitmaximizing mortgagors to optimally prepay or even default on agricultural mortgages. The model is used to quantify prepayment and credit risk by valuing the embedded options in mortgages, namely, the right of the mortgagor to prepay and to default.
Agricultural Finance Review – Emerald Publishing
Published: Nov 1, 2001
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