Using simulation to determine the costs of offering caps on adjustable rate mortages

摘要

This paper presents a methodology for using simulation to determine the cost of offering caps on adjustable rate mortgages. Caps represent a series of options, too complex to be evaluated with the options pricing model. A simulation model offers the ability to cost a variety of combinations of caps, thus providing flexibility in product offerings. Our results indicated that adjustable rate mortgages tend to be priced quite cheaply in the market. Cap costs appear to be higher than lenders may believe.