Valuation of fixed and variable rate mortgages: binomial tree versus analytical approximations

DOI10.1007/S10203-011-0117-ZMaRDI QIDQ1938899zbMATH OpenOpenAlexFDO

Authors Werner Hürlimann

Publication date 25 February 2013

Published in Decisions in Economics and Finance (Search for Journal in Brave)

Full work available at URL https://doi.org/10.1007/s10203-011-0117-z

zbMATH Keywords

Callable mortgageCIR modelHull-White modelprepayment optionrecombining binomial treeVasicek model

Mathematics Subject Classification ID

Computational methods for problems pertaining to probability theory (60-08) Diffusion processes (60J60) Microeconomic theory (price theory and economic markets) (91B24) Interest rates, asset pricing, etc. (stochastic models) (91G30) Numerical methods (including Monte Carlo methods) (91G60)

Review text

The author considers the simplified binomial tree approximation to diffusion processes proposed by \textit{M. Costabile} et al., [Decis. Econ. Finance 32, No. 2, 161--181 (2009; Zbl 1176.91152)] and analyzes its applicability to the mortgage valuation problem for the Vasicek and Cox-Ingersoll-Ross interest rate models. The pricing models for the amortized fixed and and variable rate mortgage contracts are introduced. The construction by Costabile and Massabo of computationally simple binomial trees is recalled and it is shown how to apply it to the evaluation of prices and Greeks for non-callable and callable mortgages as well as the associated prepayment option. Fixed rate mortgage under the Vasicek/CIR model are considered. Some exact and limiting analytical formulas and approximations for Vasicek model are displayed. Numerical comparisons and examples are provided.

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Cited in

(3)

• One- and multi-factor valuation of mortgages: Computational problems and shortcuts
• Fixed rate mortgages: valuation and closed form approximations
• ONE- AND MULTI-FACTOR VALUATION OF MORTGAGES: COMPUTATIONAL PROBLEMS AND SHORTCUTS

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