How Big are the Ambiguity-Based Premiums on Mortgage Insurances?

This paper studies how ambiguity aversion affects the pricing of mortgage insurance (MI). We consider pricing-kernel ambiguity arising from market incompleteness. This ambiguity model is applied to a standard framework of MI-ML (mortgage loan) structural pricing. Our quantitative results show that i...

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Bibliographic Details
Published in:The journal of real estate finance and economics 2019-01, Vol.58 (1), p.133-157
Main Authors: Chen, Chang-Chih, Chang, Chia-Chien
Format: Article
Language:English
Subjects:
Ambiguity
Economic models
Economics
Economics and Finance
Financial Services
Housing
Insurance
Mortgage insurance
Premiums
Regional/Spatial Science
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Summary:This paper studies how ambiguity aversion affects the pricing of mortgage insurance (MI). We consider pricing-kernel ambiguity arising from market incompleteness. This ambiguity model is applied to a standard framework of MI-ML (mortgage loan) structural pricing. Our quantitative results show that insurers’ ambiguity aversion generates substantial positive effects on MI premium. Ambiguity impacts are highly sensitive to loan-to-value ratio, ambiguity magnitude, and the tightness of information constraints. By using the U.S. city-level housing and mortgage data, we estimate that, on average, ambiguity aversion increases MI premium rate by 77 % (46 bps), and explains about 60–90 % of pricing errors.
ISSN:0895-5638
1573-045X
DOI:10.1007/s11146-016-9569-9