Mortgage servicing rights and interest rate volatility

While there is consensus that an increase in interest rate volatility reduces the fair value of mortgages and mortgage-backed securities, there is less agreement on the question of how volatility affects the value of mortgage servicing rights (MSRs). A volatility dependent prepayment model is needed to better reflect the true value of MSRs, say Andrew Kalotay and Qi Fu

Mortgage servicing rights (MSRs) exist simply because every mortgage loan must be serviced. Servicing of a mortgage loan involves administrative tasks such as collecting monthly payments and forwarding the proceeds to the owners of the loan (Fabozzi & Modigliani, 1992). Servicing rights on mortgage loans are important to financial institutions because they can produce significant revenue over the life of the loan, while also allowing the institution to maintain a relationship with the customer