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Mitigating financial fragility with Continuous Workout Mortgages

Research output: Contribution to journalJournal article

Published

Journal publication date01/2013
JournalJournal of Economic Behavior and Organization
Volume85
Number of pages17
Pages269-285
Early online date21/04/12
Original languageEnglish

Abstract

This paper models Continuous Workout Mortgages (CWMs) in an economic environment with refinancings and prepayments. CWMs are home loans whose balance and payments are indexed using a market-observable house price index of the pertaining locality. Our main results include: (a) explicit modelling of repayment and interest-only CWMs; (b) closed form formulæ for mortgage payment and mortgage balance of a repayment CWM; (c) a closed form formula for the actuarially fair mortgage rate of an interest-only CWM. For repayment CWMs we extend our analysis to include two negotiable parameters: adjustable "workout proportion" and adjustable "workout threshold." These results are of importance as they not only help in the understanding of the mechanics of CWMs and estimating key contract parameters, but they also provide insight on how to enhance the resilience of the financial architecture and mitigate systemic risk.

Bibliographic note

The final, definitive version of this article has been published in the Journal, Journal of Economic Behavior and Organization 85, 2013, © ELSEVIER.
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