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Mitigating financial fragility with Continuous Workout Mortgages

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  • Shiller, Robert J.
  • Wojakowski, Rafał M.
  • Ebrahim, M. Shahid
  • Shackleton, Mark B.

Abstract

This paper models Continuous Workout Mortgages (CWMs) in an economic environment with refinancings and prepayments. CWMs are home loans whose balance and payments are indexed using a market-observable house price index of the pertaining locality. Our main results include: (a) explicit modelling of repayment and interest-only CWMs; (b) closed form formula for mortgage payment and mortgage balance of a repayment CWM; (c) a closed form formula for the actuarially fair mortgage rate of an interest-only CWM. For repayment CWMs we extend our analysis to include two negotiable parameters: adjustable “workout proportion” and adjustable “workout threshold.” These results are of importance as they not only help in the understanding of the mechanics of CWMs and estimating key contract parameters, but they also provide insight on how to enhance the resilience of the financial architecture and mitigate systemic risk.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Economic Behavior & Organization.

Volume (Year): 85 (2013)
Issue (Month): C ()
Pages: 269-285

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Handle: RePEc:eee:jeborg:v:85:y:2013:i:c:p:269-285

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Web page: http://www.elsevier.com/locate/jebo

Related research

Keywords: Continuous Workout Mortgage (CWM); Repayment; House price index; Prepayment intensity; Cap and floor on continuous flow;

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References

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  1. Thorsten Beck & Ross Levine & Norman Loayza, 1999. "Financial Intermediation and Growth: Causality and Causes," Working Papers Central Bank of Chile 56, Central Bank of Chile.
  2. Ebrahim, M. Shahid & Shackleton, Mark B. & Wojakowski, Rafal M., 2011. "Participating mortgages and the efficiency of financial intermediation," Journal of Banking & Finance, Elsevier, vol. 35(11), pages 3042-3054, November.
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  13. Richard K. Green & Susan M. Wachter, 2005. "The American Mortgage in Historical and International Context," Working Paper 9094, USC Lusk Center for Real Estate.
  14. Shackleton, Mark B. & Wojakowski, Rafal, 2007. "Finite maturity caps and floors on continuous flows," Journal of Economic Dynamics and Control, Elsevier, vol. 31(12), pages 3843-3859, December.
  15. Hurst, Erik & Stafford, Frank, 2004. "Home Is Where the Equity Is: Mortgage Refinancing and Household Consumption," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 36(6), pages 985-1014, December.
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Cited by:
  1. Robert J. Shiller, 2014. "Speculative Asset Prices (Nobel Prize Lecture)," Cowles Foundation Discussion Papers 1936, Cowles Foundation for Research in Economics, Yale University.
  2. Robert J. Shiller, 2014. "Speculative Asset Prices," American Economic Review, American Economic Association, vol. 104(6), pages 1486-1517, June.

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