Optimal prepayment of Dutch mortgages

Optimal prepayment of Dutch mortgages

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Article ID: iaor20072961
Country: Netherlands
Volume: 61
Issue: 1
Start Page Number: 137
End Page Number: 155
Publication Date: Feb 2007
Journal: Statistica Neerlandica
Authors: ,
Keywords: mortgages, Netherlands
Abstract:

Valuation of the prepayment option in Dutch mortgages is complicated. In the Netherlands, mortgagors are not allowed to prepay the full mortgage loan without a compensating penalty. Only a limited amount of the initial mortgage loan can be prepaid penalty-free. We introduce a general model formulation for the valuation of limited callable mortgages, based on binomial trees. This model can be used for determining both the optimal prepayment strategy and the value of embedded prepayment options. For some mortgage types the prepayment option can be valued exactly, whereas other types require approximative methods for efficient valuation. The heuristic we propose here determines the prepayment option value efficiently and accurately for general mortgage types.

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