New numerical method via RBF approach to the price of fixed-rate mortgages

In this paper, we introduce a novel fixed-rate mortgage (FRM) pricing model that overcomes the limitations of existing approaches. Unlike traditional models, which rely on deterministic interest rate volatility and thus produce inaccurate valuations in volatile markets, our model incorporates stochastic volatility to more accurately reflect the dynamic nature of interest rate risk. This yields a pricing formula derived from a stochastic volatility framework, providing a strong theoretical basis for understanding volatility’s impact on FRM prices. We use the efficient and accurate Radial Basis Function (RBF) method to solve the resulting partial differential equation (PDE), effectively handling complex boundary conditions. Our numerical experiments demonstrate the model’s practical application and illustrate how FRM prices react to varying volatility across different market conditions. Our findings underscore the critical need for stochastic volatility in FRM valuation and offer valuable insights for improved hedging strategies, ultimately contributing to more realistic and accurate mortgage pricing and enhanced risk management for financial institutions and investors.

کلیدواژه ها:

Fixed-rate mortgages ، Stochastic volatility ، Stochastic interest rate ، Heston model ، Radial basis function