OPTIMAL CROSS-CURRENCY MORTGAGE DECISIONS

Abstract

In this paper, we study optimal mortgage decisions in a cross-currency setting. In particular, we address the question on how a household should optimally split its mortgage portfolio in a fixed rate mortgage in the domestic currency and an adjustable rate mortgage denominated in a foreign currency subject to some risk constraints. We propose an affine factor model which allows to jointly investigate the impact of variations in interest rates as well as of exchange rate fluctuations on mortgage decisions. As a case study, we apply our model to real data on Swiss and German mortgage markets and we estimate parameters using a quasi-Kalman filter approach. We then study the impact of different income splits, risk attitudes, and mortgage specifications on the household’s portfolio choice in a mean–variance optimization approach.