Hello everyone
I need help on non-recourse mortgage concept. I can understand that borrowers implicitly have a put option on their house prices. But those options they implicitly have are european or american put options? I tried to figure it out and think that borrowers actually have the american put options which they can exercise (decide to let go their houses) anytime and after they exercise, they will get another call option in case the house goes up again and they want to repay their debt to get the house back.
So it seems that borrowers have 1 american put option and additional 1 call option when they exercise the first one.
On the lender side, in order to hedge this risk, they can actually buy an option to hedge it. It seems that they can perfectly hedge this risk just by buying a european put option which has the maturity date = the maturity date of the loan they lend.
So there is question on my mind that why lenders can hedge with only a european put option while borrowers seem to get more feature from the lenders i.e. american options.
I need help on non-recourse mortgage concept. I can understand that borrowers implicitly have a put option on their house prices. But those options they implicitly have are european or american put options? I tried to figure it out and think that borrowers actually have the american put options which they can exercise (decide to let go their houses) anytime and after they exercise, they will get another call option in case the house goes up again and they want to repay their debt to get the house back.
So it seems that borrowers have 1 american put option and additional 1 call option when they exercise the first one.
On the lender side, in order to hedge this risk, they can actually buy an option to hedge it. It seems that they can perfectly hedge this risk just by buying a european put option which has the maturity date = the maturity date of the loan they lend.
So there is question on my mind that why lenders can hedge with only a european put option while borrowers seem to get more feature from the lenders i.e. american options.
