Valuation of no-negative-equity guarantees with a lower reflecting barrier. (10th March 2021)

• Record Type: Journal Article
• Authors: Thomas, R. Guy
• Is Part Of: Annals of actuarial science. Volume 15:Number 1(2021)
• Page Start: 115
• Page End: 143
• Publication Date: 2021-03-10
• Subjects: No-negative-equity guarantee, -- NNEG, -- Equity release, -- Lifetime mortgage, -- Reverse mortgage, -- Put option, -- Reflecting barrier; Actuarial science -- Periodicals; Insurance, Life -- Periodicals; 368.010941
• DOI: 10.1017/S1748499520000172
• Languages: English
• ISSNs: 1748-4995

Abstract

Abstract: If the general level of house prices falls a long way, policymakers may introduce new policies which seek to support prices. This paper considers the effect of such interventions on the valuation of no-negative-equity guarantees (NNEG) in equity release mortgages. I model interventions by a reflecting barrier expressed as a fraction of the current level of house prices. Reflection at the barrier is instantaneous, so the no-arbitrage property is preserved, and hence risk-neutral valuation of NNEG is possible. The reflecting barrier can alternatively be justified as a representation of the different economic nature of the underlying housing (and particularly freehold land) assets in NNEG valuations, compared with the underlying equity assets in many other option valuations.