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Mortgage Refinancing with Asymmetric Information

  • T.L. Tyler Yang
  • Brian A. Maris
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    Information asymmetry exists between the lender and the borrower regarding the holding period of the mortgaged real estate; the lender does not know how long the borrower plans to own the house. This information asymmetry allows the cost of obtaining a mortgage to deviate from its value to the borrower. As a result, the exercise price of the option to refinance becomes the cost to the borrower of obtaining a new mortgage instead of the outstanding balance of the existing mortgage as used in previous models. The option to refinance is a sequential option; after the borrower refinances, a new option is obtained to refinance again in the future. A mortgage refinancing model is developed taking information asymmetry and sequential refinancing into account. The model is used to solve for (1) the value to the borrower of a callable mortgage and (2) the minimum interest rate differential between the contract rate of the existing mortgage and the market interest rate needed to justify refinancing. Copyright American Real Estate and Urban Economics Association.

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    Article provided by American Real Estate and Urban Economics Association in its journal Real Estate Economics.

    Volume (Year): 21 (1993)
    Issue (Month): 4 ()
    Pages: 481-510

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    Handle: RePEc:bla:reesec:v:21:y:1993:i:4:p:481-510
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