Modeling Subprime Residential Mortgage Loans

M.A. Petersen, M.C. Senosi, S. Thomas, J. Mukuddem-Petersen, B. De Waal, and T. Bosch (S. Africa)


Subprime Residential Mortgage Loans (RMLs); Originator (OR) Valuation; Profit; Subprime Mortgage Crisis; Sub prime Risks; Credit Ratings; Discrete-Time Modeling and Optimization.


The subprime mortgage crisis (SMC) has necessitated a re evaluation of the originate-to-hold (OTH) banking model involving subprime residential mortgage loans (RMLs). One of the reasons for this has been the preference that banks have recently shown for the originate-to-distribute model involving RML securitization. In this paper, our main objective is to optimize originator (OR) valuation by considering a discrete-time OTH model involving subprime RMLs, capital and OR profit when RML losses and credit ratings are explicitly considered. This model enables us to formulate OR’s optimal valuation problem subject to RML, balance sheet, cash flow and financing constraints. In this regard, the main achievement of this paper is the discrete time optimization of OR value via suitable choices of OR’s own RML rate and supply. This enables us to establish cor responding optimal deposits, Treasuries and OR profits.

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