TITLE

THE VALUATION AND ANALYSIS OF ADJUSTABLE RATE MORTGAGES

AUTHOR(S)
Kau, James B.; Keenan, Donald C.; Muller III, Walter J.; Epperson, James F.
PUB. DATE
December 1990
SOURCE
Management Science;Dec1990, Vol. 36 Issue 12, p1417
SOURCE TYPE
Academic Journal
DOC. TYPE
Article
ABSTRACT
Securities whose payoffs depend upon the actual path of the underlying state variables pose problems for standard backward-valuation techniques. In this paper, we show that there is a method of solving such problems that requires the addition of but a single auxiliary state variable. The technique is illustrated by examining an adjustable rate mortgage (ARM) with yearly and lifetime caps. The ARM amortizes and can be prepaid at any time. We also handle other prominent features of ARMs including points and teasers. This method of using a single auxiliary state variable to handle path dependencies is a general one, applicable to more complex models of the economic environment and to other financial contracts.
ACCESSION #
4731867

 

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