Adjustable Rate Mortgages: Valuation

Adjustable Rate Mortgages: Valuation

By
Jonathan B. Berk, Richard Roll
Journal of Real Estate Finance and Economics.
1988, Vol. 1, Pages 163-184

A simulation method is employed to value Adustable Rate Mortgages, (ARMS). It is used to price two typical instruments: an ARM linked to a Treasury interest rate and an ARM linked to a “Cost of Funds” Index. Contractual provisions such as the margin over the index, caps and floors on the ARM’s rate or on the monthly prepayment, reset frequency, and the “teaser” rate are examined for their influence on value. The effects of interest rate trend and volatility are also analysed.