Working Paper: NBER ID: w13361
Authors: Ralph SJ Koijen; Otto van Hemert; Stijn van Nieuwerburgh
Abstract: The fraction of newly-originated mortgages that are of the adjustable-rate (ARM) versus the fixed-rate (FRM) type exhibits a surprising amount of time variation. A simple utility framework of mortgage choice points to the bond risk premium as theoretical determinant: when the bond risk premium is high, FRM payments are high, making ARMs more attractive. We confirm empirically that the bulk of the time variation in household mortgage choice can be explained by time variation in the bond risk premium. This is true regardless of whether bond risk premia are measured using forecasters' data, a VAR term structure model, or a simple rule-of-thumb based on adaptive expectations. This simple rule-of-thumb moves in lock-step with mortgage choice, thereby lending further credibility to a theory of strategic mortgage timing by households.
Keywords: mortgage choice; bond risk premium; adjustable-rate mortgages; fixed-rate mortgages
JEL Codes: D14; E43; G11; G12; R2
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| bond risk premia (G12) | attractiveness of ARMs relative to FRMs (E43) |
| bond risk premia (G12) | household mortgage decisions (G51) |
| high bond risk premia (G12) | expected payments on FRMs large relative to ARMs (G21) |
| expected payments on FRMs large relative to ARMs (G21) | attractiveness of ARMs (G21) |
| bond risk premia (G12) | ARM share (C22) |
| prepayment option in FRM contracts (G13) | primary relationship with bond risk premia (G12) |