Ralph S. J. Koijen
London Business School - Department of Finance; National Bureau of Economic Research (NBER)
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)
September 5, 2008
We study how the term structure of interest rates relates to mortgage choice, both at the household and the aggregate level. A simple utility framework of mortgage choice points to the long-term bond risk premium as theoretical determinant: when the bond risk premium is high, fixed-rate mortgage payments are high, making adjustable-rate mortgages more attractive. This long-term bond risk premium is markedly different from other term structure variables that have been proposed, including the yield spread and the long yield. We confirm empirically that the bulk of the time variation in both aggregate and loan-level mortgage choice can be explained by time variation in the bond risk premium. This is true whether bond risk premia are measured using forecasters' data, a VAR term structure model, or from a simple household decision rule based on adaptive expectations. This simple rule moves in lock-step with mortgage choice, lending credibility to a theory of strategic mortgage timing by households.
Number of Pages in PDF File: 67working papers series
Date posted: December 23, 2008
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