Optimal times to buy and sell a home

Matthew Lorig; Natchanon Suaysom

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arXiv · 2203.05545

Optimal times to buy and sell a home

Matthew Lorig·Natchanon Suaysom

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Abstract

We consider a financial market in which the risk-free rate of interest is modeled as a Markov diffusion. We suppose that home prices are set by a representative home-buyer, who can afford to pay only a fixed cash-flow per unit time for housing. The cash-flow is a fraction of the representative home-buyer's salary, which grows at a rate that is proportional to the risk-free rate of interest. As a result, in the long-run, higher interest rates lead to faster growth of home prices. The representative home-buyer finances the purchase of a home by taking out a mortgage. The mortgage rate paid by the home-buyer is fixed at the time of purchase and equal to the risk-free rate of interest plus a positive constant. As the home-buyer can only afford to pay a fixed cash-flow per unit time, a higher mortgage rate limits the size of the loan the home-buyer can take out. As a result, the short-term effect of higher interest rates is to lower the value of homes. In this setting, we consider an investor who wishes to buy and then sell a home in order to maximize his discounted expected profit. This leads to a nested optimal stopping problem. We use a nonnegative concave majorant approach to derive the investor's optimal buying and selling strategies. Additionally, we provide a detailed analytic and numerical study of the case in which the risk-free rate of interest is modeled by a Cox-Ingersoll-Ross (CIR) process. We also examine, in the case of CIR interest rates, the expected time that the investor waits before buying and then selling a home when following the optimal strategies.

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Matthew Lorig, Natchanon Suaysom. 2022-03-10. Optimal times to buy and sell a home. https://arxiv.org/abs/2203.05545

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