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Risk-neutral valuation of the non-recourse protection in reverse mortgages: A case study for Korea

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  • Kim, Joseph H.T.
  • Li, Johnny S.H.

Abstract

Reverse mortgages are increasingly seen as an alternative source of retirement income among Koreans. All reverse mortgage loans in Korea are sold with a non-recourse protection, limiting the borrowers' exposure to house price appreciation risk. This paper performs risk-neutral valuation for the non-recourse protection in the Korean reverse mortgage market. Specifically, we adopt a multivariate DCC-GARCH model that incorporates different forms of correlations between the economic variables. Risk-neutralization is accomplished using the minimum relative entropy method. Our valuation results reveal several limitations of the fee structure currently used by reverse mortgage providers. Recommendations to improve the fee structure are provided.

Suggested Citation

  • Kim, Joseph H.T. & Li, Johnny S.H., 2017. "Risk-neutral valuation of the non-recourse protection in reverse mortgages: A case study for Korea," Emerging Markets Review, Elsevier, vol. 30(C), pages 133-154.
    • Handle: RePEc:eee:ememar:v:30:y:2017:i:c:p:133-154
    DOI: 10.1016/j.ememar.2016.10.002
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    2. Kogure Atsuyuki & Fushimi Takahiro, 2018. "A Bayesian Pricing of Longevity Derivatives with Interest Rate Risks," Asia-Pacific Journal of Risk and Insurance, De Gruyter, vol. 12(1), pages 1-30, January.
    3. Dowd, Kevin & Buckner, Dean & Blake, David & Fry, John, 2019. "The valuation of no-negative equity guarantees and equity release mortgages," Economics Letters, Elsevier, vol. 184(C).

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