Breakeven Determination of Loan Limits for Reverse Mortgages under Information Asymmetry
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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 price volatility, mortality distribution, and interest rates. We also pay special attention to the important implication of mortgage lenders’ informational advantage over reverse mortgage borrowers concerning housing market risk. In reverse mortgage markets, the elderly borrowers typically hold far less, relative to the lenders, or no information about the lenders’ underlying mortgage pools. 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 of reverse mortgages. We further find that the maximum loan amount of a reverse mortgage decreases in the correlation between the returns on the pooled underlying housing properties but increases with the number of the pooled mortgages.
KeywordsReverse Mortgages Heterogeneous Beliefs Information Asymmetry Loan Limits
JELG21 G22 J14
We would like to thank Chun-seob Lee, Steven Li, Dogan Tirtiroglu, Seow Eng Ong, Kwong Wing Chau, Zhi Dong, an anonymous referee and participants at the 2011 Asian Real Estate Society-American Real Estate and Urban Economics Society Joint International Conference and the 2011 Asia-Pacific Real Estate Research Symposium for helpful comments. Any errors are our own.
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