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Fixed-Rate Endowment Mortgage and Mortgage Indemnity Valuation

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  • Azevedo-Pereira, Jose A
  • Newton, David P
  • Paxson, Dean A

Abstract

We use a contingent claims framework for valuing the default and prepayment embedded options in certain British fixed-rate endowment mortgages, with a (capped) mortgage indemnity guarantee (MIG). This methodology provides a template for the borrower, lender, and insurer to compare mortgage terms, including the fairness of contract rates, arrangement fees, prepayment penalties, any MIG premiums required, and co-insurance exposure. With empirical inputs, this model may eventually be useful as a "mark-to-value" proxy for all parties, as expected parameters change (especially interest rate and house price levels, and expected future volatilities), for purposes of determining "valued added accounting", appropriate reserves, and indeed for setting premiums and business drivers. Fixed-rate endowment mortgages differ from fixed-rate repayment mortgages primarily because, in the event of early termination, the amount owed by the borrower is a function of the evolution of the term structure of interest rates, whereas for a repayment mortgage it is pre-determined. We compare endowment and repayment mortgages for different levels of loan-to-value ratios, interest rate and house price volatilities. Copyright 2003 by Kluwer Academic Publishers

Suggested Citation

  • Azevedo-Pereira, Jose A & Newton, David P & Paxson, Dean A, 2003. "Fixed-Rate Endowment Mortgage and Mortgage Indemnity Valuation," The Journal of Real Estate Finance and Economics, Springer, vol. 26(2-3), pages 197-221, March-May.
    • Handle: RePEc:kap:jrefec:v:26:y:2003:i:2-3:p:197-221
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    Citations

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    Cited by:

    1. Bilgi Yilmaz & A. Sevtap Selcuk-Kestel, 2019. "Computation of Hedging Coefficients for Mortgage Default and Prepayment Options: Malliavin Calculus Approach," The Journal of Real Estate Finance and Economics, Springer, vol. 59(4), pages 673-697, November.
    2. Chang-Chih Chen & Chia-Chien Chang, 2019. "How Big are the Ambiguity-Based Premiums on Mortgage Insurances?," The Journal of Real Estate Finance and Economics, Springer, vol. 58(1), pages 133-157, January.
    3. Nicholas Sharp & David Newton & Peter Duck, 2008. "An Improved Fixed-Rate Mortgage Valuation Methodology with Interacting Prepayment and Default Options," The Journal of Real Estate Finance and Economics, Springer, vol. 36(3), pages 307-342, April.
    4. Shiller, Robert J. & Wojakowski, Rafal M. & Ebrahim, M. Shahid & Shackleton, Mark B., 2019. "Continuous Workout Mortgages: Efficient pricing and systemic implications," Journal of Economic Behavior & Organization, Elsevier, vol. 157(C), pages 244-274.
    5. Wu, Yang-Che & Huang, Yi-Ting & Lin, Shih-Kuei & Chuang, Ming-Che, 2017. "Fair valuation of mortgage insurance under stochastic default and interest rates," The North American Journal of Economics and Finance, Elsevier, vol. 42(C), pages 433-447.
    6. Ming Shann Tsai & Shu Ling Chiang, 2016. "The Valuation Model for a Risky Asset When Its Risky Factors Follow Gamma Distributions," International Review of Finance, International Review of Finance Ltd., vol. 16(3), pages 421-444, September.
    7. Robert J. Shiller & Rafal M. Wojakowski & M. Shahid Ebrahim & Mark B. Shackleton, 2017. "Continuous Workout Mortgages: Efficient Pricing and Systemic Implications," Cowles Foundation Discussion Papers 3016, Cowles Foundation for Research in Economics, Yale University.
    8. Tsai, Ming-Shann & Liao, Szu-Lang & Chiang, Shu-Ling, 2009. "Analyzing yield, duration and convexity of mortgage loans under prepayment and default risks," Journal of Housing Economics, Elsevier, vol. 18(2), pages 92-103, June.
    9. Patel, Nimesh & Daglish, Toby, 2011. "Fixed come hell or high water? Selection and prepayment of fixed rate mortgages outside the US," Working Paper Series 4107, Victoria University of Wellington, The New Zealand Institute for the Study of Competition and Regulation.
    10. Szu‐Lang Liao & Ming‐Shann Tsai & Shu‐Ling Chiang, 2008. "Closed‐Form Mortgage Valuation Using Reduced‐Form Model," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 36(2), pages 313-347, June.
    11. Nicholas Sharp & Paul Johnson & David Newton & Peter Duck, 2009. "A New Prepayment Model (with Default): An Occupation-time Derivative Approach," The Journal of Real Estate Finance and Economics, Springer, vol. 39(2), pages 118-145, August.
    12. Sven Balder & Wolf Christoph Gramatke & Antje Mahayni & Gordon Müller-Seitz & Jörg Sydow, 2014. "Bewertung von Kündigungsrechten in der privaten Wohnungsbaufinanzierung — Über den separaten Ausweis von Margen- und Kursschäden," Schmalenbach Journal of Business Research, Springer, vol. 66(1), pages 3-36, February.

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