Continuous Workout Mortgages
Robert J. Shiller
Yale University - Cowles Foundation; National Bureau of Economic Research (NBER); Yale University - International Center for Finance
Rafal M. Wojakowski
University of Surrey; Lancaster University - Management School
Muhammed Shahid Ebrahim
Mark B. Shackleton
Lancaster University - Department of Accounting and Finance
April 20, 2011
This paper models Continuous Workout Mortgages (CWMs) in an economic environment with refinancings and prepayments by employing a market-observable variable such as the house price index of the pertaining locality. Our main results include: (a) explicit modelling of repayment and interest-only CWMs; (b) closed form formulae 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 guidance on how to enhance the resilience of the financial architecture and mitigate systemic risk.
Number of Pages in PDF File: 41
Keywords: Continuous Workout Mortgage (CWM), Repayment, Interest-only, House price index, Prepayment intensity, Cap and floor on continuous flow
JEL Classification: C63, D11, D14, D92, G13, G21, R31working papers series
Date posted: April 27, 2011
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