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SUMMARY
Application of Financial Engineering Method on Real Estate : Value Assess ment and Ris k Management of MBS and REITs
Geun- Y ong K im J u- hy un Y oon
Korean economy encountered seriou s liquidity problem s, so-called foreign exchange and financial crisis, in 1997. Real estate securitization w as so urgently needed to aid restructuring of entrepreneurs and banks that government has implemented several m easures to promote real estate finance in Korea. Asset securitization inclu ding m ortgage securitization w as introduced to Korea in 1998 with the enactment of the Asset Securitization Law that w as followed by the Act on Housing Mortgage Securitization Companies. And real estate investment companies were allow ed with the enactm ent of the Real Estate Investment Companies Law in July 2001
In spite that the new financing m ethods like securitization and investment finance were institutionally introduced in real estate sector,
it is early to expect these new methods work efficiently. Since real estate sector in Korea has been working based on the speculative incentives rather than the cash-flow incentives and the supporting system of the new financing methods is in the prem ature stage.
One of the issues in supporting system is that pricing model of financial products concerning real estate properties is very rare to be u sed. In order to prom ote securitization and investm ent in the real estate sector, analytical tools like financial engineering should be applied to evaluate and design financial comm odities concerning real estate like ABS, MBS, REITs. This study is the trial to adopt financial engineering m ethod to evalu ate MBS and REITs. Thus, the purpose of this study is to set up the pricing model of MBB(mortgage-backed-bond) and REITs, and to identify the financial risks embedded in real estate financial products in order to suggest the risk m anagement m ethod . This study consists of five chapters. The second chapter, next to an introduction, reviews theoretical background of pricing m odels on general bonds and stocks in advance to the application of the m odel to real estate financial products. For the case of bond pricing m odel, option-free bond and option-embedded bond are separately reviewed in consideration of applicability to the MBB with call option that allow s prepayment. And for the case of stock pricing model, dividend evaluation m odel and growth opportunity model are reviewed.
In chapter three, pricing models reveiwed in the second chapter are applied to MBS and REITs. This chapter suggests pricing models of MBB without option and then MBB with call option by u sing the principle of pricing bonds. The basic frameworks of the pricing model employed are Option Pricing Models su ggested by Cox, Ross & Rubinstein (1979) and Black(1976). These theoretical m odels will be used to analyze each value of MBS and call option given to the issuer by exemplifying the MBS that have been issued by KoMoCo, lately. And then, the pricing
m odel of REITs is suggested based on Capozza & Lee(1995, 1996), dividend evaluation model, and growth opportunity m odel that are review ed in the second chapter.
The fourth chapter classifies the risk types of real estate financial products and suggests the risks management methods. Securitization is one way to hedge risks prevailed in real estate, however, it is not sufficient since real estate financial products includes intrinsic risks of financial products as w ell as additional risk transferred from real estate.
Recently m easuring the risks by VaR(Value at Risk) is attempted as a comprehensive management m ethod of each risk. Unfortunately, this study does not attempt to m easure VaR due to the lack of concerning data, instead, suggest measurement method like delta analysis, historical simulation method, stress testing method, and structural Monte-Carlo analysis etc.
The last chapter summarizes the core contents of each chapter. It insists the necessity of data accumulation for concrete results of the m odel analysis and the need of infrastructure that is channeling the analytical results to the individual investors.
In the case of hou sing mortgage loans, the loan borrowers have the right to redeem the loan earlier than the date due. By this reason, the financial institutions usually issue MBB with embedded call option that enables them to buy back MBB earlier than its maturity so as to coincide the cash flows of housing mortgage loans to those of MBB.