Breakeven Determination of Loan Limits for Reverse Mortgages under Information Asymmetry

48 Pages Posted: 6 Mar 2011 Last revised: 28 Dec 2012

See all articles by Ming Pu

Ming Pu

Southwestern University of Finance and Economics (SWUFE) - Research Institute of Economics & Management

Gang-Zhi Fan

School of Management, Guangzhou University

Yongheng Deng

Wisconsin School of Business, University of Wisconsin-Madison

Multiple version iconThere are 2 versions of this paper

Date Written: April 1, 2012

Abstract

Since the loan limit of a reverse mortgage is a major concern for the borrower as well as the lender, this paper attempts to develop an option-based model to evaluate the loan limits of reverse mortgages. Our model can identify several crucial determinants for reverse mortgage loan limits, such as initial housing price, expected housing price growth, house volatility, mortality distribution, and interest rates. We also pay special attention to the important implication of information asymmetry between lenders and elderly borrowers with respect to the beliefs on housing market risk. In reverse mortgage markets, elderly borrowers typically hold far less or no information about the characteristics associated with lenders’underlying property pools compared to the lenders. Such information asymmetry leads these two categories of market participants to generate different perspectives on the risk of the collateralized properties, which can be identified to be important in determining the maximum loan amounts in this analysis. We further find that the maximum loan amount of a reverse mortgage decreases in the correlation between the systematic return and the idiosyncratic return on its underlying housing property but increases with the number of the pooled reverse mortgages.

Keywords: Reverse Mortgages, Heterogeneous Beliefs, Information Asymmetry, Loan Limits

JEL Classification: G21, G22, J14, R2

Suggested Citation

Pu, Ming and Fan, Gang-Zhi and Deng, Yongheng, Breakeven Determination of Loan Limits for Reverse Mortgages under Information Asymmetry (April 1, 2012). Available at SSRN: https://ssrn.com/abstract=1774722 or http://dx.doi.org/10.2139/ssrn.1774722

Ming Pu

Southwestern University of Finance and Economics (SWUFE) - Research Institute of Economics & Management ( email )

55 Guanghuacun Street
Chengdu, Sichuan 610074
China

Gang-Zhi Fan (Contact Author)

School of Management, Guangzhou University ( email )

230 Wai Huan Xi Road
Guangzhou Higher Education Mega Center
Guangzhou, Guangdong 510006
China

Yongheng Deng

Wisconsin School of Business, University of Wisconsin-Madison ( email )

4110 Grainger Hall
975 University Avenue
Madison, WI 53706
United States
+1 (608) 262-4865 (Phone)

HOME PAGE: http://https://bus.wisc.edu/faculty/yongheng-deng

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