Can Household Benefit from Stochastic Programming Models?

Kourosh Marjani Rasmussen, Claus A. Madsen, Rolf Poulsen

    Research output: Contribution to journalJournal articleResearchpeer-review

    Abstract

    The Danish mortgage market is large and sophisticated. However, most Danish mortgage banks advise private home-owners based on simple, if sensible, rules of thumb. In recent years a number of papers (from Nielsen and Poulsen in J Econ Dyn Control 28:1267–1289, 2004 over Rasmussen and Zenios in J Risk 10:1–18, 2007 to Pedersen et al. in Ann Oper Res, 2013) have suggested a model-based, stochastic programming approach to mortgage choice. This paper gives an empirical comparison of performance over the period 2000–2010 of the rules of thumb to the model-based strategies. While the rules of thumb slightly outperform a passive benchmark on average and are less risky than pure adjustable rate loans, we find considerable gains from using the model-based strategies. Using a strategy that minimizes conditional-value-at-risk lowers average effective yearly interest rate over a 10-year horizon by 0.3–0.9 %-points (depending on the borrower’s level of conservatism) compared to the rules of thumb without increasing the risk. The answer to the question in the title is thus affirmative.
    Original languageEnglish
    JournalComputational Management Science
    Volume11
    Issue number1-2
    Pages (from-to)5-23
    Number of pages19
    ISSN1619-697X
    DOIs
    Publication statusPublished - 2014

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