Pricing and Risk Analysis of Reverse Mortgage Based on Stochastic Interest Rate

Abstract:

This paper develops and implements a dynamic house pricing model and stochastic interest rate model for Lump sum pricing model and equal payment pricing model of reverse mortgage products for the empirical research of Shanghai. A vector autoregressive model(VAR) for economic variables including house prices index, CPI and GDP based on the data in Shanghai is used to better capture the interrelationship between economic variables and simple prediction. The Nowman’s CKLS model is also used to represent the stochastic interest rate. The present value of net pay off of Lump sum reverse mortgage to assets profitability is computed. The commonly risk measure VaR(Value at Risk) is used to analyze risk in order to give an index to solvency and liquidity.

Key words:reverse mortgage; vector autoregressive model; stochastic interest rate model