Property Derivatives and Index-Linked Mortgages

Abstract

Economists have forcefully argued for the introduction and use of property derivatives as a hedge against house price risk (e.g. Shiller and Weiss, 1999). The rationale for these financial instruments seems clear, as many households are heavily invested in housing and standard financial instruments offer a poor hedge. In practice, however, most of the property derivatives available have been targeted to meet the needs of institutional investors, not those of owner-occupiers. Building on the recent launch of the first Swiss property derivative, we here propose index-linked mortgages tailored to retail consumers. The payments of these mortgages depend on the corresponding housing market performance. We further discuss the stabilization of the homeowner's net wealth, price the instruments, and quantify the expected decrease in the mortgage default risk achieved by these immunization effects.

Keywords: House Price Risk, Mortgage Default Risk, Rent or Buy, Hedonic Index

JEL Classification: D14, G10, G21, R31