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An approximation approach for valuing reverse mortgages

Author

Listed:
  • Tsay, Jing-Tang
  • Lin, Che-Chun
  • Prather, Larry J.
  • Buttimer, Richard J.

Abstract

We derive an approximate pricing formula for use in reverse mortgage valuation that allows the house price and interest rate to be stochastic with a deterministic distribution of termination time. We compare the results from the approximate pricing formula to a simulation and find that the approximate pricing formula can significantly reduce computational intensity and provide a close approximation to simulation results. The approximation approach enables reverse mortgage holders to undertake complicated portfolio optimization and hedging analyses.

Suggested Citation

  • Tsay, Jing-Tang & Lin, Che-Chun & Prather, Larry J. & Buttimer, Richard J., 2014. "An approximation approach for valuing reverse mortgages," Journal of Housing Economics, Elsevier, vol. 25(C), pages 39-52.
    • Handle: RePEc:eee:jhouse:v:25:y:2014:i:c:p:39-52
    DOI: 10.1016/j.jhe.2014.03.001
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    References listed on IDEAS

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    1. Mitchell, Olivia S. & Piggott, John, 2004. "Unlocking housing equity in Japan," Journal of the Japanese and International Economies, Elsevier, vol. 18(4), pages 466-505, December.
    2. Thomas P. Boehm & Michael C. Ehrhardt, 1994. "Reverse Mortgages and Interest Rate Risk," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 22(2), pages 387-408, June.
    3. Linda S. Klein & C.F. Sirmans, 1994. "Reverse Mortgages and Prepayment Risk," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 22(2), pages 409-431, June.
    4. Chan, K C, et al, 1992. "An Empirical Comparison of Alternative Models of the Short-Term Interest Rate," Journal of Finance, American Finance Association, vol. 47(3), pages 1209-1227, July.
    5. Vasicek, Oldrich, 1977. "An equilibrium characterization of the term structure," Journal of Financial Economics, Elsevier, vol. 5(2), pages 177-188, November.
    6. Peter Chinloy & Isaac F. Megbolugbe, 1994. "Reverse Mortgages: Contracting and Crossover Risk," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 22(2), pages 367-386, June.
    7. Seungryul Ma & Yongheng Deng, 2006. "Insurance Premium Structure of Reverse Mortgage Loans in Korea," Working Paper 8568, USC Lusk Center for Real Estate.
    8. Edward J. Szymanoski, 1994. "Risk and the Home Equity Conversion Mortgage," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 22(2), pages 347-366, June.
    9. Tyler Yang & Che-Chun Lin & Man Cho, 2011. "Collateral Risk in Residential Mortgage Defaults," The Journal of Real Estate Finance and Economics, Springer, vol. 42(2), pages 115-142, February.
    10. Vasicek, Oldrich Alfonso, 1977. "Abstract: An Equilibrium Characterization of the Term Structure," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 12(4), pages 627-627, November.
    11. Thomas J. Miceli & C.F. Sirmans, 1994. "Reverse Mortgages and Borrower Maintenance Risk," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 22(2), pages 433-450, June.
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    Cited by:

    1. Iván de la Fuente & Eliseo Navarro & Gregorio Serna, 2020. "Reverse Mortgage Risks. Time Evolution of VaR in Lump-Sum Solutions," Mathematics, MDPI, vol. 8(11), pages 1-17, November.
    2. Kyung Jin Choi & Byungkwon Lim & Jaehwan Park, 2020. "Evaluation of the Reverse Mortgage Option in Korea: A Long Straddle Perspective," IJFS, MDPI, vol. 8(3), pages 1-14, September.
    3. Yang, Jaehwan & Yuh, Yoonkyung, 2019. "Reverse Mortgages for Managing Longevity Risk in Korea," Hitotsubashi Journal of Economics, Hitotsubashi University, vol. 60(1), pages 21-40, June.
    4. Fuente, Iván de la & Navarro, Eliseo & Serna, Gregorio, 2021. "Estimating regulatory capital requirements for reverse mortgages. An international comparison," International Review of Economics & Finance, Elsevier, vol. 74(C), pages 239-252.

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    More about this item

    Keywords

    G21; Reverse mortgage; Longevity risk; Option pricing;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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