Residential Mortgage Credit Derivatives
30 Pages Posted: 16 Nov 2011
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Residential Mortgage Credit Derivatives
Residential Mortgage Credit Derivatives
Date Written: Winter 2011
Abstract
As the fallout from subprime losses clearly demonstrates, the credit risk in residential mortgages is large and economically significant. To manage this risk, this article proposes the creation of derivative instruments based on the credit losses of a reference mortgage pool. We argue that these derivatives would enable banks to retain whole loans while also enjoying the capital benefits of hedging the credit risk in their mortgage portfolios. In comparisons of hedging effectiveness, the analysis shows that instruments based on credit losses outperform contracts based on house price appreciation.
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Residential Mortgage Credit Derivatives
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