The purpose of this chapter is to familiarize the reader with the concept of mortgages and to describe the behavioural factors behind decisions to prepay and default on mortgages that ultimately influence the evolution of real-estate markets. The other scope of this chapter is to highlight the complexity of the financial modelling related to the real-estate area, and to mortgages in general. Mortgage loans are contracts carrying real-estate risk. They represent a large part of the assets in the banking systemsworldwide and banks find it difficult to hedge this asset class against real-estate risk. Prepayments and default models are essential to any risk management enterprise looking to contain this type of risk, and they are reviewed in this chapter. There are many models proposed in the academic and practitioner literature, but there is not a single model that is widely accepted.
Preface: recent developments in financial modelling and risk management