We investigate the effect of adding a distinct feature from the Danish mortgage market to the US market, namely a buyback option, which enables mortgagors to buy back their share of the mortgage-backed security at market price. Extending a standard referenced pricing model, we find that the introduction of the buyback option reduces the credit spread required by the financial intermediary with 23%, potentially reducing the contingent liability of the US government. Furthermore, the buyback option protects households against the risk of being locked in after an increase in interest rates. In particular, this could benefit low-to-middle income households.
By Mikkel Svenstrup and Søren Willemann