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Optimal Cross-Currency Mortgage Decisions

Author

Listed:
  • EVA LÃœTKEBOHMERT

    (Department of Quantitative Finance, Institute for Economic Research, University of Freiburg, Rempartstr. 16, 79098 Freiburg, Germany)

  • THORSTEN SCHMIDT

    (Department of Mathematical Stochastics, Mathematical Institute, University of Freiburg, Ernst-Zermelo-Str. 1, 79104 Freiburg, Germany)

  • TIANJIAO ZHU

    (Department of Quantitative Finance, Institute for Economic Research, University of Freiburg, Rempartstr. 16, 79098 Freiburg, Germany)

Abstract

In this paper, we study optimal mortgage decisions in a cross-currency setting. In particular, we address the question on how a household should optimally split its mortgage portfolio in a fixed rate mortgage in the domestic currency and an adjustable rate mortgage denominated in a foreign currency subject to some risk constraints. We propose an affine factor model which allows to jointly investigate the impact of variations in interest rates as well as of exchange rate fluctuations on mortgage decisions. As a case study, we apply our model to real data on Swiss and German mortgage markets and we estimate parameters using a quasi-Kalman filter approach. We then study the impact of different income splits, risk attitudes, and mortgage specifications on the household’s portfolio choice in a mean–variance optimization approach.

Suggested Citation

  • Eva Lãœtkebohmert & Thorsten Schmidt & Tianjiao Zhu, 2022. "Optimal Cross-Currency Mortgage Decisions," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 25(03), pages 1-31, May.
    • Handle: RePEc:wsi:ijtafx:v:25:y:2022:i:03:n:s0219024922500108
    DOI: 10.1142/S0219024922500108
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