Valuation and optimal exercise of Dutch Mortgage loans with prepayment restrictions

Prepayment of Dutch mortgage loans is restricted to a fixed amount per calendar year. Due to path dependence the valuation of these mortgage loans is more complicated than the valuation of unrestricted prepayment options. In this paper we derive an optimal and efficient strategy to price interest-only mortgages with restricted repayments. For tax reasons an interest-only mortgage is the most popular mortgage type in the Netherlands.The optimal strategy also provides a rational explanation why empirical prepayment models find that prepayments peak in December. Our results indicate that a restricted prepayment option still has significant value.

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