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Model Risk in Risk Analysis for No-Negative-Equity-Guarantees

Jr-Wei Huang, Sharon S. Yang and Chuang-Chang Chang
The Journal of Derivatives Summer 2021, 28 (4) 87-110; DOI: https://doi.org/10.3905/jod.2020.1.125
Jr-Wei Huang
is an associate professor of risk management and insurance in the department of economics and deputy director of the Research Center of Hubei Financial Development and Financial Security at Hubei University of Economics in Wuhan, China
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Sharon S. Yang
is a professor in the Department of Money and Banking, a Research Fellow at the Risk and Insurance Research Center, and director of the NNIP & Nomura SITE Financial Center in the College of Commerce at National Chengchi University in Taipei City, Taiwan
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Chuang-Chang Chang
is a professor in the Department of Finance at National Central University in Taoyuan City, Taiwan, and president of the Chung-Hua Institution for Economic Research, in Taipei City, Taiwan
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Abstract

Understanding the risk for No-Negative-Equity-Guarantees (NNEGs) requires the proper modeling of the housing return, interest rate, and mortality rate dynamics. This article investigates the model risk for the risk measures of NNEGs by calculating the Value-at-Risk (VaR) and Conditional-Tail-Expectation (CTE) from the provider perspective, with an emphasis on the housing price return model. Therefore, we propose a jump ARMA-GARCH model, according to nationwide house price return data in the UK. Interest rate and mortality rate dynamics are assumed to follow the CIR model and the CBD model, respectively. Our numerical analyses reveal that the housing price risk, interest-rate risk, and longevity risk can affect the VaR and CTE of NNEGs, with the impact being as significant as that for housing risk. The VaR and CTE of NNEGs will be greater for female borrowers than for male borrowers, essentially because females have a longer life expectancy. The proposed framework can help financial institutions manage the major three risk factors for NNEGs and assist in meeting the regulator’s concerns.

TOPICS: Quantitative methods, real estate, VAR and use of alternative risk measures of trading risk

Key Findings

  • ▪ We investigate model risk in risk analysis for No-Negative-Equity-Guarantees.

  • ▪ Our numerical analyses reveal that the housing price risk, interest-rate risk, and longevity risk can affect the VaR and CTE of NNEGs, with the impact being as significant as that for housing risk.

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The Journal of Derivatives: 28 (4)
The Journal of Derivatives
Vol. 28, Issue 4
Summer 2021
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Model Risk in Risk Analysis for No-Negative-Equity-Guarantees
Jr-Wei Huang, Sharon S. Yang, Chuang-Chang Chang
The Journal of Derivatives May 2021, 28 (4) 87-110; DOI: 10.3905/jod.2020.1.125

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Model Risk in Risk Analysis for No-Negative-Equity-Guarantees
Jr-Wei Huang, Sharon S. Yang, Chuang-Chang Chang
The Journal of Derivatives May 2021, 28 (4) 87-110; DOI: 10.3905/jod.2020.1.125
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  • Article
    • Abstract
    • MODELING HOUSING, INTEREST RATE, AND LONGEVITY RISK
    • OUTLINE AND MEASURING THE RISK OF NNEGS
    • EMPIRICAL AND NUMERICAL ANALYSIS
    • SENSITIVITY ANALYSIS ON THE RISK MEASURES FOR NNEGS
    • CONCLUSION
    • APPENDIX A
    • APPENDIX B
    • ENDNOTES
    • REFERENCES
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