Can home-owners benefit from stochastic programming models? A study of mortgage choice in Denmark

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.