Optimal Exercise of Mortgage Options: Default and Refinancing

45 Pages Posted: 1 Jan 2014 Last revised: 16 Sep 2017

See all articles by Rina Ray

Rina Ray

University of Colorado at Denver

Dean Taylor

University of Colorado at Denver - Business School

Date Written: September 13, 2017

Abstract

We are the first to provide closed-form analytic solutions for the joint problem of mortgage refinancing and default. Our solution takes into account reduction in mortgage interest rates and the "cash-out" motive for refinancing. The model predicts how long the households are likely to wait before defaulting, even if default is costless, when their mortgage goes "underwater" and we also derive the optimal default strategy under costly default. Our solutions for default are generally consistent with empirical works on mortgage default. Although our refinancing results are comparable to other closed-form solutions and numerical models, we offer additional results for "cash-out" refinancing.

Keywords: Default, Household Finance, Mortgage, Real Options, Refinancing

JEL Classification: D14, G11, G21, R20

Suggested Citation

Ray, Rina and Taylor, Dean G., Optimal Exercise of Mortgage Options: Default and Refinancing (September 13, 2017). Available at SSRN: https://ssrn.com/abstract=2373337 or http://dx.doi.org/10.2139/ssrn.2373337

Rina Ray (Contact Author)

University of Colorado at Denver ( email )

Box 173364
1250 14th Street
Denver, CO 80217
United States
303-315-8455 (Phone)

Dean G. Taylor

University of Colorado at Denver - Business School ( email )

1250 14th St.
Denver, CO 80204
United States

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