Valuation of no-negative-equity guarantees with a lower reflecting barrier

This draft paper develops some of the thoughts in my earliest blog post on NNEG valuation. 

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 discuss past examples of interventions, and policymaker statements which suggest the prospect of future interventions.  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.

Full text available on my main page.

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