Developing Equity Release Markets: Risk Analysis for Reverse Mortgages and Home Reversions

North American Actuarial Journal, Forthcoming

49 Pages Posted: 17 Jan 2013 Last revised: 1 Apr 2014

See all articles by Daniel H. Alai

Daniel H. Alai

University of Kent

Hua Chen

University of Hawaiʻi at Mānoa

Daniel Cho

University of New South Wales (UNSW) - ARC Centre of Excellence in Population Ageing Research (CEPAR)

Katja Hanewald

University of New South Wales - ARC Centre of Excellence in Population Ageing Research (CEPAR)

Michael Sherris

University of New South Wales - ARC Centre of Excellence in Population Ageing Research and School of Risk and Actuarial Studies; UNSW Australia Business School

Date Written: October 1, 2013

Abstract

Equity release products are sorely needed in an ageing population with high levels of home ownership. There has been a growing literature analyzing risk components and capital adequacy of reverse mortgages in recent years. However, little research has been done on the risk analysis of other equity release products, such as home reversion contracts. This is partly due to the dominance of reverse mortgage products in equity release markets worldwide. In this paper, we compare cash flows and risk profiles from the provider’s perspective for reverse mortgage and home reversion contracts. An at-home/in long-term care split termination model is employed to calculate termination rates, and a vector autoregressive (VAR) model is used to depict the joint dynamics of economic variables including interest rates, house prices and rental yields. We derive stochastic discount factors from the no arbitrage condition and price the no negative equity guarantee in reverse mortgages and the lease for life agreement in the home reversion plan accordingly. We compare expected payoffs and assess riskiness of these two equity release products via commonly used risk measures, i.e., Value-at-Risk (VaR) and Conditional Value-at-Risk (CVaR).

Keywords: Reverse Mortgage, Home Reversion, Vector Autoregressive Models, Stochastic Discount Factors, Risk-Based Capital

JEL Classification: G12, G21, G32

Suggested Citation

Alai, Daniel H. and Chen, Hua and Cho, Daniel and Hanewald, Katja and Sherris, Michael, Developing Equity Release Markets: Risk Analysis for Reverse Mortgages and Home Reversions (October 1, 2013). North American Actuarial Journal, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2198619 or http://dx.doi.org/10.2139/ssrn.2198619

Daniel H. Alai

University of Kent ( email )

Cornwallis Building
Canterbury, CT2 7NF
United Kingdom

Hua Chen (Contact Author)

University of Hawaiʻi at Mānoa ( email )

2404 Maile Way, E-602e
Honolulu, HI 96822
United States
(808) 956-8063 (Phone)
(808) 956-9887 (Fax)

Daniel Cho

University of New South Wales (UNSW) - ARC Centre of Excellence in Population Ageing Research (CEPAR) ( email )

Level 6, Central Lobby (enter via East Lobby)
Australian School of Business Building
Sydney, New South Wales NSW 2052
Australia

Katja Hanewald

University of New South Wales - ARC Centre of Excellence in Population Ageing Research (CEPAR) ( email )

ARC Centre of Excellence in Population Ageing Rese
The University of New South Wales
Sydney, New South Wales NSW 2052
Australia

Michael Sherris

University of New South Wales - ARC Centre of Excellence in Population Ageing Research and School of Risk and Actuarial Studies ( email )

Australian School of Business
Quadrangle Building
Sydney, NSW 2052
Australia
+61 2 9385 2333 (Phone)
+61 2 9385 1883 (Fax)

HOME PAGE: http://www.asb.unsw.edu.au/schools/Pages/MichaelSherris.aspx

UNSW Australia Business School ( email )

Sydney, NSW 2052
Australia

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