I am becoming more interested in mortgage valuation and would like some pointers on the basic valuation process for a mortgage. I understand there is likely an entire field of study devoted to valuing mortgages but I am looking to understand the basics.
My thoughts so far:
- Define starting mortgage financing rate, length of mortgage etc.
- Monte-Carlo simulate mortgage rates (using which stochastic process?)
- Within each simulated rate path, if the simulated rate drops to a new low by a certain threshold, assume a refinance at the new lower rate
- Within each simulated rate path, calculate payments at each time step using Amortization equations and financed rate at that time step
- Sum payments at each time step for each path, average across all simulated paths, discount to present
Would something like this work? I guess it still doesn't account for default on the mortgage loan. Any pointers would be appreciated.