Ralph S. J. Koijen
London Business School - Department of Finance; Centre for Economic Policy Research (CEPR)
Otto Van Hemert
IMC Asset Management
Stijn Van Nieuwerburgh
New York University Stern School of Business, Department of Finance; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)
NBER Working Paper No. w13361
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.
Number of Pages in PDF File: 53
Date posted: September 10, 2007
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