TY - JOUR T1 - Rent-to-Own Housing Contracts under Financial Constraints JF - The Journal of Derivatives SP - 62 LP - 78 DO - 10.3905/jod.2017.25.2.062 VL - 25 IS - 2 AU - Sanjiv Jaggia AU - Pratish Patel Y1 - 2017/11/30 UR - https://pm-research.com/content/25/2/62.abstract N2 - The aftermath of the 2008 financial crisis left a large number of houses whose previous owners had not been able to keep up mortgage payments and either abandoned the property or were forced out by foreclosure, in many cases leaving the house in questionable physical condition. Potential new occupants, also weakened by the crisis, did not have the financial resources to qualify for a new mortgage. The rent-to-own (RTO) contract offers a solution. The financially constrained buyer enters into a kind of lease agreement in which he/she rents the house but also acquires the option to purchase it during the term of the lease for a price fixed at the beginning. The combination of downpayment, monthly rent, and purchase price amounts to market rent on the house plus the call option premium. If the Tenant-Buyer’s financial condition improves over the lifetime of the lease, typically 1–3 years, and the market value of the house at the end is above the “exercise” price in the RTO contract, the option is exercised. In this article, Jaggia and Patel develop a model for the value of the RTO contract. They then apply it to evaluate RTO contract pricing under the housing market conditions in 20 major U.S. cities. An important mathematical tool used in deriving the model is the Esscher transform, and the paper provides a nice intuitive explanation of how it works.TOPICS: Real estate, financial crises and financial market history, quantitative methods ER -