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Optimal Mortgage Refinancing: A Closed Form Solution

Author

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  • Sumit Agarwal
  • John C Driscoll
  • David Laibson

Abstract

We derive the first closed-form optimal mortgage refinancing rule. The expression is derived by using the Lambert-W function to solve a tractable class of mortgage refinancing problems. We calibrate our solution and show that our quantitative results closely match those reported by researchers who use numerical methods.
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Suggested Citation

  • Sumit Agarwal & John C Driscoll & David Laibson, 2008. "Optimal Mortgage Refinancing: A Closed Form Solution," Levine's Working Paper Archive 122247000000002021, David K. Levine.
  • Handle: RePEc:cla:levarc:122247000000002021
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    References listed on IDEAS

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    Cited by:

    1. Breuer, Wolfgang & Soypak, K. Can, 2015. "Framing effects in intertemporal choice tasks and financial implications," Journal of Economic Psychology, Elsevier, vol. 51(C), pages 152-167.
    2. Tullio Jappelli & Annalisa Scognamiglio, 2016. "Monetary Policy, Mortgages and Consumption: Evidence from Italy," CSEF Working Papers 454, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.
    3. John Y. Campbell, 2016. "Restoring Rational Choice: The Challenge of Consumer Financial Regulation," American Economic Review, American Economic Association, vol. 106(5), pages 1-30, May.
    4. Piazzesi, M. & Schneider, M., 2016. "Housing and Macroeconomics," Handbook of Macroeconomics, Elsevier.
    5. Werner Hürlimann, 2012. "Valuation of fixed and variable rate mortgages: binomial tree versus analytical approximations," Decisions in Economics and Finance, Springer;Associazione per la Matematica, vol. 35(2), pages 171-202, November.
    6. Keys, Benjamin J. & Pope, Devin G. & Pope, Jaren C., 2016. "Failure to refinance," Journal of Financial Economics, Elsevier, vol. 122(3), pages 482-499.
    7. Guiso, Luigi & Sodini, Paolo, 2013. "Household Finance: An Emerging Field," Handbook of the Economics of Finance, Elsevier.
    8. Sumit Agarwal & Richard J. Rosen & Vincent Yao, 2016. "Why Do Borrowers Make Mortgage Refinancing Mistakes?," Management Science, INFORMS, vol. 62(12), pages 3494-3509, December.
    9. Johan Almenberg & Artashes Karapetyan, 2011. "The Hidden Costs of Hidden Debt," Working Papers 1206, Departament Empresa, Universitat Autònoma de Barcelona, revised Oct 2011.
    10. Agarwal, Sumit & Ben-David, Itzhak & Yao, Vincent, 2017. "Systematic mistakes in the mortgage market and lack of financial sophistication," Journal of Financial Economics, Elsevier, vol. 123(1), pages 42-58.
    11. Hancock, Diana & Passmore, Wayne, 2016. "Cost of funds indexed mortgage contracts with government-backed catastrophic insurance (COFI-Cats): A realistic alternative to the 30-year fixed-rate mortgage?," Journal of Economics and Business, Elsevier, vol. 84(C), pages 109-130.
    12. Aytek Malkhozov & Philippe Mueller & Andrea Vedolin & Gyuri Venter, 2013. "Mortgage Hedging in Fixed Income Markets," FMG Discussion Papers dp722, Financial Markets Group.
    13. Neil Bhutta & Benjamin J. Keys, 2016. "Interest Rates and Equity Extraction during the Housing Boom," American Economic Review, American Economic Association, vol. 106(7), pages 1742-1774, July.
    14. Andersen, Steffen & Campbell, John Y. & Meisner-Nielsen, Kasper & Ramadorai, Tarun, 2014. "Inattention and Inertia in Household Finance: Evidence from the Danish Mortgage Market," Scholarly Articles 17492179, Harvard University Department of Economics.
    15. Johan Almenberg & Artashes Karapetyan, 2012. "The hidden costs of hidden debt," Working Paper 2011/22, Norges Bank.
    16. Toshio Kimura & Naoki Makimoto, 2008. "Optimal Mortgage Refinancing with Regime Switches," Asia-Pacific Financial Markets, Springer;Japanese Association of Financial Economics and Engineering, vol. 15(1), pages 47-65, March.
    17. Khandani, Amir E. & Lo, Andrew W. & Merton, Robert C., 2013. "Systemic risk and the refinancing ratchet effect," Journal of Financial Economics, Elsevier, vol. 108(1), pages 29-45.
    18. repec:eee:juecon:v:99:y:2017:i:c:p:62-78 is not listed on IDEAS
    19. Rodney Ramcharan & Amir Kermani & Marco Di Maggio, 2015. "Monetary Policy Pass-Through: Household Consumption and Voluntary Deleveraging," 2015 Meeting Papers 256, Society for Economic Dynamics.
    20. Peter Diep & Andrea L. Eisfeldt & Scott Richardson, 2016. "Prepayment Risk and Expected MBS Returns," NBER Working Papers 22851, National Bureau of Economic Research, Inc.
    21. Barry Bosworth & Rosanna Smart, 2009. "The Wealth of Older Americans and the Sub-Prime Debacle The Wealth of Older Americans and the Sub-Prime Debacle," Working Papers, Center for Retirement Research at Boston College wp2009-21, Center for Retirement Research, revised Nov 2009.
    22. Anson T. Y. Ho & Jie Zhou, 2016. "Housing and Tax-Deferred Retirement Accounts," Staff Working Papers 16-24, Bank of Canada.
    23. Sumit Agarwal & Gene Amromin & Souphala Chomsisengphet & Tim Landvoigt & Tomasz Piskorski & Amit Seru & Vincent Yao, 2015. "Mortgage Refinancing, Consumer Spending, and Competition: Evidence from the Home Affordable Refinancing Program," NBER Working Papers 21512, National Bureau of Economic Research, Inc.

    More about this item

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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