Valuing US and Canadian mortgage servicing rights with default and prepayment

The increasing use of securitized mortgage throughout the world has led to the creation of an asset class, the mortgage servicing right (MSR). The typical MSR used in the United States and Canada is a contract between the owners of a pool of residential mortgages and a financial institution under which the institution provides retail-level services to borrowers. This paper presents an options-based MSR valuation mode that incorporates both prepayment and default. Numerical results indicate that the MSR value is sensitive to interest rate and housing volatility parameters, as well as to the correlation coefficient between those parameters.