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An Analysis of the Impact of Transaction Cost on the Borrower‟s Refinancing Decisions

Author(s): Di Jin | Jin Zheng | Nan Zhang | Siwei Gan

Journal: Journal of Economics, Business and Management
ISSN 2301-3567

Volume: 2;
Issue: 3;
Start page: 224;
Date: 2014;
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Keywords: Mortgage refinancing | refinancing value | transaction fee | risk-neutral pricing.

Assuming that the market interest rate follows the Vasicek model, this paper focuses on finding an optimal refinancing interest rate boundary where a proportional transaction fee is charged when the mortgage borrower decides to leverage on the refinancing strategy to lower his financial cost. An optimal refinancing premium is introduced by risk-neutral analysis, then is used to recursively determine the minimization of discounted payment streams of the mortgage contract. Intriguing properties of the optimal refinancing boundary are discovered with numerical simulations.
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