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J. Risk Financial Manag. 2017, 10(1), 1; doi:10.3390/jrfm10010001

Portfolio Optimization and Mortgage Choice

Department of Mathematical Sciences, University of Copenhagen, Universitetsparken 5, DK-2100 Copenhagen, Denmark
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Academic Editor: Michael McAleer
Received: 6 October 2016 / Revised: 23 December 2016 / Accepted: 27 December 2016 / Published: 3 January 2017
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Abstract

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. View Full-Text
Keywords: optimal mortgage choice; stochastic control theory; stochastic interest rate optimal mortgage choice; stochastic control theory; stochastic interest rate
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Nordfang, M.-B.; Steffensen, M. Portfolio Optimization and Mortgage Choice. J. Risk Financial Manag. 2017, 10, 1.

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