Home prices follow are assumed to follow geometric Brownian motion. The evolution of home prices is a function of:

  • The risk-free interest rate.
  • Expected home price appreciation.
  • The volatility of home prices.

The Figure to the left illustrates the home price model used by Bond Lab. So long, as home price volatility is less than (2 * Expected HPA) the zero origin cannot be reached. This implies, the upper limit of home price volatility increases with the expected rate of home price appreciation.

The home price path presented in the Figure simulates 10 paths assumes the following:

  • The short rate = 0.025%.
  • Expected home price appreciation = 2.5%
  • Home price volatility = 5.0%

The simulated home price paths are passed to the mortgage default model. Based on the mortgage loan or pool's updated loan to value ratio the default model generates the expected monthly default rate (expressed on an annualized basis). The figure to the left illustrates the expected default curves based on 1,000 simulated home price paths

Copyright, Bond Lab Technologies, Inc.

Copyright, Bond Lab Technologies, Inc.

Bond Lab Technologies Modeling the Home Price Process

Structured Finance Analytics