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Housing Market Bubbles and Mortgage Contract Design: Implications for Mortgage Lenders and Households

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  • Geoffrey Poitras

    (Beedie School of Business, Simon Fraser University, Vancouver, BC V5A 1S6, Canada)

  • Giovanna Zanotti

    (Department of Management, Economics, and Quantitative Methods, Università degli studi di Bergamo, via Salvecchio 19, 24129 Bergamo, Italy)

Abstract

This paper explores the implications of a housing market bubble for three critical elements of mortgage contract design: difference between term to maturity and amortization period; prepayment options; and, lender recourse in the event of default. Using an extension of classical immunization theory, this paper provides equilibrium conditions demonstrating the risk reduction benefits of shorter term to contract maturity at origination for lenders of long amortization mortgage contracts. In addition, the risks of underpricing prepayment and no recourse default options in the mortgage contract when compared with full recourse mortgage contracts having yield maintenance prepayment penalties are explored by contrasting the ability of US and Canadian mortgage funding systems to withstand a housing market bubble collapse that might occur.

Suggested Citation

  • Geoffrey Poitras & Giovanna Zanotti, 2018. "Housing Market Bubbles and Mortgage Contract Design: Implications for Mortgage Lenders and Households," JRFM, MDPI, vol. 11(3), pages 1-18, July.
    • Handle: RePEc:gam:jjrfmx:v:11:y:2018:i:3:p:42-:d:158481
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