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Modeling Housing Price Dynamics and their Impact on the Cost of no-Negative-Equity-Guarantees for Equity Releasing Products

Author

Listed:
  • Jr-Wei Huang

    (Department of Insurance at Hubei University of Economics
    Hubei University of Economics)

  • Sharon S. Yang

    (Department of Money and Banking at National Cheng-Chi University
    National Chengchi University)

  • Chuang-Chang Chang

    (Department of Finance at National Central University
    Chung-Hua Institution for Economic Research)

Abstract

We investigate model risk in pricing no-negative-equity guarantees (NNEGs) with the aim of identifying the housing risks involved in equity-release products. To analyze the regional and local effect in the house price modeling, we evaluate different models using the house price index (HPI) based on the cities of London, Manchester and Coventry and the UK nationwide HPI respectively. The ARMA-GARCH jump model that can capture the characteristics of jump persistence, autocorrelation and volatility clustering are proposed according to the model fittings. To investigate the model risk on the cost of NNEGs, we then derive the risk-neutral valuation framework using the conditional Esscher transform technique (Bühlmann et al. 1996). Our numerical analyses reveal that the housing model risk affects the costs of NNEGs significantly. In addition, the cost of NNEGs is significantly different for different cities due to localized effect. Therefore, the basis risk is large enough to matter when pricing NNEGs.

Suggested Citation

  • Jr-Wei Huang & Sharon S. Yang & Chuang-Chang Chang, 2021. "Modeling Housing Price Dynamics and their Impact on the Cost of no-Negative-Equity-Guarantees for Equity Releasing Products," The Journal of Real Estate Finance and Economics, Springer, vol. 63(2), pages 249-279, August.
    • Handle: RePEc:kap:jrefec:v:63:y:2021:i:2:d:10.1007_s11146-020-09776-3
    DOI: 10.1007/s11146-020-09776-3
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