Reverse Mortgage Pricing and Risk Analysis Allowing for Idiosyncratic House Price Risk and Longevity Risk

39 Pages Posted: 11 Feb 2014

See all articles by Adam Wenqiang Shao

Adam Wenqiang Shao

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

Katja Hanewald

UNSW Sydney - School of Risk & Actuarial Studies and 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: February 7, 2014

Abstract

Reverse mortgages provide an alternative source of funding for retirement income and health care costs. The two main risks that reverse mortgage providers face are house price risk and longevity risk. Recent real estate literature has shown that the idiosyncratic component of house price risk is large. We analyse the combined impact of house price risk and longevity risk on the pricing and risk profile of reverse mortgage loans in a stochastic multi-period model. The model incorporates a new hybrid hedonic-repeat-sales pricing model for houses with specific characteristics, as well as a stochastic mortality model for mortality improvements along the cohort direction (the Willis-Sherris model). Our results show that pricing based on an aggregate house price index does not accurately assess the risks underwritten by reverse mortgage lenders, and that failing to take into account cohort trends in mortality improvements substantially underestimates the longevity risk involved in reverse mortgage loans.

Keywords: Equity release products, idiosyncratic house price risk, stochastic mortality, Willis-Sherris mortality model

JEL Classification: G21, G22, G32, R31, L85

Suggested Citation

Shao, Adam Wenqiang and Hanewald, Katja and Sherris, Michael, Reverse Mortgage Pricing and Risk Analysis Allowing for Idiosyncratic House Price Risk and Longevity Risk (February 7, 2014). UNSW Australian School of Business Research Paper No. 2014ACTL01. Available at SSRN: https://ssrn.com/abstract=2393813 or http://dx.doi.org/10.2139/ssrn.2393813

Adam Wenqiang Shao (Contact Author)

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

CEPAR, Level 3
East Wing, NICTA Building, UNSW
Sydney, New South Wales NSW 2052
Australia

Milliman ( email )

One Pennsylvania Plaza 38th Floor
New York, NY 10119
United States

Katja Hanewald

UNSW Sydney - School of Risk & Actuarial Studies and ARC Centre of Excellence in Population Ageing Research (CEPAR) ( email )

School of Risk & Actuarial Studies
UNSW Sydney
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 )

UNSW Business School
Risk and Actuarial Studies
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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