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Mitigating financial fragility with Continuous Workout Mortgages

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

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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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
Contact details of provider: Web page: http://www.elsevier.com/locate/jebo

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  1. 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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  8. Stiglitz, Joseph E, 1988. "Money, Credit, and Business Fluctuations," The Economic Record, The Economic Society of Australia, vol. 64(187), pages 307-22, December.
  9. Robert J. Shiller & Allan N. Weiss, 1994. "Home Equity Insurance," Cowles Foundation Discussion Papers 1074, Cowles Foundation for Research in Economics, Yale University.
  10. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
  11. Richard Stanton & Nancy Wallace, 1998. "Mortgage Choice: What's the Point?," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 26(2), pages 173-205.
  12. 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.
  13. Brent W. Ambrose & Richard J. Buttimer Jr., 2012. "The Adjustable Balance Mortgage: Reducing the Value of the Put," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 40(3), pages 536-565, 09.
  14. 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.
  15. Hosios, Arthur J & Peters, Michael, 1989. "Repeated Insurance Contracts with Adverse Selection and Limited Commitment," The Quarterly Journal of Economics, MIT Press, vol. 104(2), pages 229-53, May.
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