Working Paper: CEPR ID: DP10117
Authors: Cristian Badarinza; John Y. Campbell; Tarun Ramadorai
Abstract: The relative popularity of adjustable-rate mortgages (ARMs) and fixed-rate mortgages (FRMs) varies considerably both across countries and over time. We ask how movements in current and expected future interest rates affect the share of ARMs in total mortgage issuance. Using a nine-country panel and instrumental variables methods, we present evidence that near-term (one-year) rational expectations of future movements in ARM rates do affect mortgage choice, particularly in more recent data since 2001. However longer-term (three-year) rational forecasts of ARM rates have a weaker effect, and the current spread between FRM and ARM rates also matters, suggesting that households are concerned with current interest costs as well as with lifetime cost minimization. These conclusions are robust to alternative (adaptive and survey-based) models of household expectations.
Keywords: adjustable-rate; fixed-rate; household finance; interest rate; international; mortgage choice
JEL Codes: G21; N20; R21; R31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| near-term rational expectations of future ARM rates (E43) | mortgage choice (G51) |
| current spread between FRM and ARM rates (E43) | mortgage choice (G51) |
| longer-term forecasts of ARM rates (E47) | mortgage choice (G51) |
| households' expectations about future ARM rates (D84) | decision to choose ARMs over FRMs (G21) |
| current cost minimization behavior (D21) | mortgage choice (G51) |
| households' forward-looking behavior for near-term forecasts (D15) | mortgage choice (G51) |
| households' anticipation of longer-term movements in interest rates (D15) | mortgage choice (G51) |