Do economic uncertainty and persistence in housing prices matter on mortgage insurance?

Abstract

In this paper, we employ an option-pricing model that considers the effects of autocorrelation, economic policy uncertainty, and macroeconomic conditions to derive closed-form formulas of mortgage insurance (MI). When fitting the U.S. housing and mortgage data, our pricing model produces significantly well-fitting MI market quotes. Then, we design a framework to measure the magnitudes of these three effects on MI valuation. The autocorrelation effect dominates economic uncertainty and macroeconomic effects. On average, the effects of autocorrelation, economic uncertainty, and macroeconomic factors increase the MI premium rate by 65.173 bps, 14.616 bps, and 12.114 bps, respectively. During periods of heightened monetary policy uncertainty, the magnitude of the economic uncertainty effect is greater than that of the macroeconomic effects. Moreover, the magnitude of the economic uncertainty effect increases rapidly for a higher loan-to-value ratio (LTV), particularly when the LTV exceeds a threshold of 0.8.