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Valuation of non-negative equity guarantees, considering contagion risk for house prices under the HJM interest rate model

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  • Fen-Ying Chen
  • Sharon S. Yang
  • Hong-Chih Huang

Abstract

Writing non-negative equity guarantees (NNEGs) is the main method used to deal with the risks of equity release products in the United Kingdom. The existing empirical literature indicates the potential for contagion of interregional and international house prices, but no studies have modeled these contagion effects. This paper applies a Merton-jump-diffusion model to propose a general model to investigate the impacts of house price contagion on the valuation of NNEGs. We derive a closed-form solution for the price of NNEGs and use an analytic formula to investigate contagion effects on NNEGs efficiently. This research establishes that ignoring the contagion effects of house prices can lead to underestimating of the value of NNEGs. Treating the contagion effect is critical for valuing NNEGs, in light of the development of equity release products.

Suggested Citation

  • Fen-Ying Chen & Sharon S. Yang & Hong-Chih Huang, 2021. "Valuation of non-negative equity guarantees, considering contagion risk for house prices under the HJM interest rate model," Quantitative Finance, Taylor & Francis Journals, vol. 21(9), pages 1551-1565, September.
    • Handle: RePEc:taf:quantf:v:21:y:2021:i:9:p:1551-1565
    DOI: 10.1080/14697688.2021.1890805
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    Cited by:

    1. Tsai, Pei-Hsuan & Wang, Ying-Wei & Chang, Wen-Chang, 2023. "Hybrid MADM-based study of key risk factors in house-for-pension reverse mortgage lending in Taiwan's banking industry," Socio-Economic Planning Sciences, Elsevier, vol. 86(C).
    2. Badescu, Alexandru & Quaye, Enoch & Tunaru, Radu, 2022. "On non-negative equity guarantee calculations with macroeconomic variables related to house prices," Insurance: Mathematics and Economics, Elsevier, vol. 103(C), pages 119-138.
    3. de la Fuente, Iván & Navarro, Eliseo & Serna, Gregorio, 2023. "Proposal for calculating regulatory capital requirements for reverse mortgages," Socio-Economic Planning Sciences, Elsevier, vol. 88(C).

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