Securitization and Tranching Longevity and House Price Risk for Reverse Mortgages

Reverse mortgages are new financial products that allow the elders to convert their home equity into cash until they die. From the provider’s perspective, longevity risk and house price risk are the major risks involved with reverse mortgages. This paper proposes a securitization method to transfer the risks associated with reverse mortgages and focuses on tranching longevity and house price risks for different investors. The structure of securitization for reverse mortgages is similar to that for collateralized debt obligation(CDO). Different to price CDO, we model the dynamics of future mortality and house price instead of default rate. Thus, we model the house price index using ARMA-GARCH process. To deal with longevity risk for elders, we use the CBD model (Cairns et al, 2006) to project future mortality. We propose a risk neutral valuation framework and employ the conditional Esscher transform to price the fair spreads for different tranche investors. The problems of using static mortality table and model risk on pricing fair spread are investigated numerically.