Mortgage contract design and systemic risk immunization

Geoffrey Poitras and Giovanna Zanotti

International Review of Financial Analysis, 2016, vol. 45, issue C, 320-331

Abstract: This paper provides theoretical results for the design of contracts used in the market for residential household mortgages and mortgage securities. Critical elements in the problem of immunizing systemic risk through efficient contract design are identified. Using an extension of classical immunization theory, this paper demonstrates that systemic risk of long amortization mortgage contracts is reduced when term to maturity of the contract at origination is significantly less than the amortization period. In addition, incorporating prepayment and limited recourse default options into the mortgage contract increases systemic risk when compared with full recourse mortgage contracts having yield maintenance prepayment penalties. The theoretical results are used to evaluate the systemic risk management problems that have plagued the US mortgage funding system.

Keywords: Classical fixed income immunization theory; Mortgage contract design; Systemic risk management (search for similar items in EconPapers)
Date: 2016
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:finana:v:45:y:2016:i:c:p:320-331

DOI: 10.1016/j.irfa.2014.10.011

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