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VALUATION OF MORTGAGE INSURANCE CONTRACTS WITH COUNTERPARTY DEFAULT RISK: REDUCED-FORM APPROACH

Published online by Cambridge University Press:  11 March 2014

Chia-Chien Chang
Chia-Chien Chang*
Affiliation:
Department of Finance, National Kaohsiung University of Applied Science and RIRC, NCCU, Taipei, Taiwan. Phone: +886-7-3814526
*
E-mail: cchiac@kuas.edu.tw
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Abstract

In the recent subprime mortgage crisis, which has caused banks and insurance companies to go bankrupt or into acquisition, the lender and insurer have exhibited not only correlated defaults when exposed to common risk factors but also counterparty default risk, which is triggered by mortgage defaults. Given the correlated defaults and the counterparty default risk, we use the reduced-form approach to derive the closed-form formulas of mortgage insurance contracts with premium refunds, annual premiums and upfront premiums. Regardless of the nature of the premium structures, the numerical analysis with parameter calibration demonstrates that both the correlated defaults and the counterparty default risk significantly impact mortgage insurance premiums, particularly in long-term mortgage loans.

Keywords

Correlated defaultscounterparty default riskreduced-form modelmortgage insurance premium structures
Type
Research Article
Information
ASTIN Bulletin: The Journal of the IAA , Volume 44 , Issue 2 , May 2014 , pp. 303 - 334
Copyright
Copyright © ASTIN Bulletin 2014 

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