Valuation and Optimal Exercise of Dutch Mortgage Loans with Prepayment Restrictions
15 Pages Posted: 26 Mar 2006
Date Written: March 23, 2006
Prepayment of Dutch mortgage loans is restricted to a fixed amount per calendar year. Due to path dependence the valuation of these mortgage loans is more complicated than the valuation of unrestricted prepayment options. In this paper we derive an optimal and efficient strategy to price interest-only mortgages with restricted prepayments. For tax reasons an interest-only mortgage is the most popular mortgage type in the Netherlands. The optimal strategy also provides a rational explanation why empirical prepayment models find that prepayments peak in December. Our results indicate that a restricted prepayment option still has significant value.
Keywords: mortgage valuation, partial prepayments, binomial trees
JEL Classification: C61, C63, G21
Suggested Citation: Suggested Citation