On Pricing and Hedging the No-Negative-Equity Guarantee in Equity Release Mechanisms

Abstract

In a roll-up mortgage, the borrower receives a loan in the form of a lump sum. The loan is rolled up with interest until the borrower dies, sells the house, or moves into long-term care permanently. The house is sold at that time, and the proceeds are used to repay the loan and interest. Most roll-up mortgages are sold with a no-negative-equity guarantee (NNEG), which caps the redemption amount at the lesser of the face amount of the loan and the sale proceeds. The core of this study is to develop a framework for pricing and managing the risks of the NNEG.