Research On Fixed-rate Mortgage Pricing Based On Embedded Option

Commercial banks of China’s Fixed-rate Mortgage has been developing very rapidly, whichwere introduced in2006. Different from Adjustable-rate Mortgage, the rate of Fixed-ratemortgage has been priced by commercial banks independently, but recent pricing practicereveal, due to be lack of experience, the pricing of Fixed-rate Mortgage is unreasonable,which not only affects the healthy development of Fixed-rate Mortgage and also leads toasymmetry of risk-income between borrowers and lenders.Under the background of market-oriented interest rate, the direction of changes in interestrate is uncertain so that Fixed-rate Mortgage also faces prepayment risk when the interestrate declines. This paper fully considers it as an embedded option. When commercial banksloan Fixed-rate Mortgage, it is equivalent to sell a put option simultaneously, whichexecution price is the original loan contract interest rate. On the basis of the market interestrate follows geometric Brownian motion; it builds a minimized variance risk model and amaximized return per unit of risk model about Fixed-rate Mortgage, combining with thedevelopment present situation of Fixed-rate Mortgage in China, it chooses the Fixed-rateMortgage maximized return per unit of risk model as the optimization model in the paper’sempirical research.This paper combines the existing interest rate pricing models for commercial banks in Chinawith China Everbright Bank’s interest rates data, and analyzes the empirical model whetherit is reasonable or not, from both the theoretical and the practical aspects. Following themodel, it prices Fixed-rate Mortgages for the commercial banks in China, which provides areliable method on the Fixed-rate Mortgage prepayment risk management for thecommercial banks in China.