Abstract
A fixedrate borrower has the option to pay off the loan after paying certain penalties. The borrower will do so only if the spot interest rate falls sufficiently below the contract rate. Assuming that the spot interest rate follows a meanreverting process, this article finds that the fixedrate borrower has a more valuable prepayment option such that the interest rate differential between a fixedand a floatingrate loan expands when the term of the loan lasts longer, either the steadystate or initial spot interest rate is lower, penalties associated with prepayment are lower, or interest rates increase at an unpredictable rate.
| Original language | English |
|---|---|
| Pages (from-to) | 83-91 |
| Number of pages | 9 |
| Journal | Journal of Fixed Income |
| Volume | 25 |
| Issue number | 4 |
| DOIs | |
| State | Published - 1 Mar 2016 |