Measurement And Control Of Interest Rate Risk In Reverse Mortgages

The aging trend of population poses a great challenge to our existing security system. Meanwhile the Family Planning causes the substantial emergence of the "4-2-1" families and the burden of Children-Support becomes increasingly heavier. New ways are needed to solve these problems. Reverse mortgage is such a choice and it can be an effective supplement to our security system. Interest rate risk is an important aspect in the operation of reverse mortgage. This risk can result in other risks either directly or indirectly. Therefore measuring and managing interest rate risk is the key to the success of reverse mortgage.This paper mainly studies the measurement and control of interest rate risk in reverse mortgage. First the paper introduces the interest rate risk in fixed and floating situations and studies the risk from the net proceeds of Special Purpose Vehicle (SPV). Then it introduces Option-Adjusted-Spreads Model (OAS model) and the definition of Effective Duration and Effective Convexity. By revealing the embedded options in reverse mortgage, this paper proves the applicability of OAS model in reverse mortgage. When stating the specific application of OAS model in reverse mortgage, Binary Tree Model is used to construct the interest rate scenarios and an innovative prepayment model of reverse mortgage is put forward. This paper also studies the impacts of interest rate insurance on reverse mortgage. Finally this paper gives some advice on how to prevent the interest rate risk of reverse mortgage, including charging liquidated damages to prepayment, setting up floating repayment interest rate, using interest rate derivatives and giving full play to the role of government.