Participating Mortgages and the Efficiency of Financial Intermediation

Abstract

This paper distinguishes Participating Mortgages (PMs) from Convertible Mortgages. We study variants of PMs to demonstrate that they have the potential of improving the efficiency of a financial system. We resort to closed-form formulae to price profit caps and floors identified in variants of PMs. Our contribution includes finite maturity pricing formulae, which are scarce in real estate finance as most contracts are of definite tenure. We also focus on random tenure mortgages, which occur in the context of default and pre-payment risk. Finally, we conclude our study with a public policy implication of employing PMs as workout loans especially in the ongoing sub-prime crisis.

Keywords: Participating Mortgage (PM), Shared Appreciation Mortgage (SAM), Shared Income Mortgage (SIM), Shared Equity Mortgage (SEM), Profit Caps and Floors

JEL Classification: C63, D11, D14, D92, G13, G21, R31