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Answer: Turnover is primarily a function of interest rates and tends to be independent of seasonality but highly responsive to the so-called media effect
**511.1. B. False.** Turnover is mostly independent of interest rates (except for the lock-in effect) but dependent on seasonality; the "media effect" is associated with refinancing. In regard to (A), (C) and (D) each is TRUE. To model the refinance component, it is common to specify an incentive function. Defaults are a source of prepayment: mortgage guarantors pay the outstanding principal and interest if and when the borrower defaults. Partial prepayments are called curtailments.
Author: Manit Arora
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Q-511.1. According to Tuckman, "A prepayment model uses loan characteristics and the economic environment (i.e., interest rates and sometimes housing prices) to predict prepayments. The most common practice identifies four components of prepayments, namely, in order of importance, refinancing, turnover, defaults, and curtailments. These components are typically modeled separately, and their parameters estimated or calibrated so as to approximate available historical data." About these four components, each of the following is true EXCEPT which is false?
A
Refinancing is often modeled with an incentive function for a pool or group of loans in a pool, and then prepayments due to refinancing are defined as a nondecreasing function of that incentive; an example of an incentive function is
B
Turnover is primarily a function of interest rates and tends to be independent of seasonality but highly responsive to the so-called media effect
C
Defaults are a source of prepayments in the sense that mortgage guarantors pay interest and principal outstanding when a borrower defaults
D
Curtailments are partial prepayments by a particular borrower. These tend to be most important when loans are older and balances are low
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