Author: Sun-Joong Yoon(Dongguk University), Chang Gyun Park(Chung-Ang University)

Abstract

This paper develops the model to determine the interest spreads of non-recourse mortgage loans using option pricing models and then analyzes the main factors that affect them. According to the results, the most significant factors that influence the interest spreads are the loan-to-value (LTV) and the volatility of home prices. Using the iterative method to determine the early-exercise-boundary, we calculated the implied interest spreads based on the empirical housing process. For the volatility of 20 percent and the loan-to-value of 70 percent, the interest spread is relatively small as 8 basis points. However, if the loan-to-value increases
by 90 percent, the spread increases by 29 basis points. In addition, if the volatility increases to 25 percent and 30 percent, the spread becomes 19 and 33 basis points, respectively. By contrast, the level of a market interest rate and the time-to-maturity on loans cannot make significant changes in the spread. These results provide the implication that the financial institutions should estimate the both factors exactly when they introduce the non-recourse mortgage loan in Korea.