What Should You Pay to Cap your ARM?—A Note on Capped Adjustable Rate Mortgages

In this paper, an Adjustable Rate Mortgage (ARM) and a Fixed Rate Mortgage (FRM) are formalized and studied in a simple continuous-time setting under the assumption of a simple one-factor Affine Term Structure (ATS). Through an application of existing results from ATS theory, it is shown that when the short rate reaches a certain pre-determined boundary, the constant payment stream on a new FRM equals the payments on an existing ARM. Hereby, this paper provides a theoretical build-in cap on the formalized ARM. The finite boundary for the short-rate suggests that certain caps on ARMs should (in theory) be offered free of charge

Judgments of Time in Traffic Related Decision-Making Situation

Judgments of time can have a crucial role for the choices drivers take while in traffic. At the same time drivers’ value of time is often predicted as being the core benefit from new road development schemes (Mackie, Jara-Días, Fowkes, 2001; Beesley, 1965). This paper uses the theoretical perspective of Kahneman & Tversky’s (1979) Prospect Theory to investigate how time is judged in traffic situations. In particular, it is examined how the framing of time- prospects, influence the drivers’ judgments. To investigate this a questionnaire was distributed on the internet. 213 participants were presented with 6 different situations related to time in traffic and asked to choose between two different time-prospects in each of the 6 situations. The 6 different choice situations were each framed in both a positive and a negative formulation. The individual participant was presented with only one of the two formulations in each choice situation. The results from the experiment indicate that the framing of the specific choice situation play a role in drivers’ judgments of time in traffic related situations, as Prospect Theory predicts. Also, the results show that special consideration must be given to judgments of time as compared to choices involving judgments of objects or money, as the perception of time differs from the perception of objects or money

Portfolio Optimization and Mortgage Choice

This paper studies the optimal mortgage choice of an investor in a simple bond market with a stochastic interest rate and access to term life insurance. The study is based on advances in stochastic control theory, which provides analytical solutions to portfolio problems with a stochastic interest rate. We derive the optimal portfolio of a mortgagor in a simple framework and formulate stylized versions of mortgage products offered in the market today. This allows us to analyze the optimal investment strategy in terms of optimal mortgage choice. We conclude that certain extreme investors optimally choose either a traditional fixed rate mortgage or an adjustable rate mortgage, while investors with moderate risk aversion and income prefer a mix of the two. By matching specific investor characteristics to existing mortgage products, our study provides a better understanding of the complex and yet restricted mortgage choice faced by many household investors. In addition, the simple analytical framework enables a detailed analysis of how changes to market, income and preference parameters affect the optimal mortgage choice

Portfolio Optimization and Mortgage Choice

This paper studies the optimal mortgage choice of an investor in a simple bond market with a stochastic interest rate and access to term life insurance. The study is based on advances in stochastic control theory, which provides analytical solutions to portfolio problems with a stochastic interest rate. We derive the optimal portfolio of a mortgagor in a simple framework and formulate stylized versions of mortgage products offered in the market today. This allows us to analyze the optimal investment strategy in terms of optimal mortgage choice. We conclude that certain extreme investors optimally choose either a traditional fixed rate mortgage or an adjustable rate mortgage, while investors with moderate risk aversion and income prefer a mix of the two. By matching specific investor characteristics to existing mortgage products, our study provides a better understanding of the complex and yet restricted mortgage choice faced by many household investors. In addition, the simple analytical framework enables a detailed analysis of how changes to market, income and preference parameters affect the optimal mortgage choice