Subprime mortgage funding and liquidity risk

Abstract

In this article, we use actuarial methods to solve a nonlinear stochastic optimal liquidity risk management problem for subprime originators with deposit inflow rates and marketable securities allocation as controls. The main objective is to minimize liquidity risk in the form of funding and credit crunch risk in an incomplete market. In order to accomplish this, we construct a stochastic model that incorporates originator mortgage and deposit reference processes. Finally, numerical examples that illustrate the main modeling and optimization features of the article are provided.