Pricing Mortgages: Endogenous Interest Rate and Leverage

42 Pages Posted: 4 Mar 2016

See all articles by Liang Peng

Liang Peng

Smeal College of Business, The Pennsylvania State University

Date Written: February 2016

Abstract

Mortgages are priced alone two dimensions – the interest rate and the leverage. This paper develops a simple model of a mortgage contract, in which differences in the borrower and the lender’s risk preference jointly determine the equilibrium interest rate and leverage. This model provides novel predictions, including counter-cyclical leverage of real estate: loan to value ratios of newly generated mortgages should be higher when property values are lower. Co-integration tests on commercial mortgage data provide generally supporting evidence for the predictions, and the evidence on counter-cyclical leverage is very strong both statistically and economically.

Keywords: mortgage, interest rate, financial leverage, commercial real estate

JEL Classification: G12, G21, E32, E44

Suggested Citation

Peng, Liang, Pricing Mortgages: Endogenous Interest Rate and Leverage (February 2016). Available at SSRN: https://ssrn.com/abstract=2741478 or http://dx.doi.org/10.2139/ssrn.2741478

Liang Peng (Contact Author)

Smeal College of Business, The Pennsylvania State University ( email )

University Park
State College, PA 16802
United States

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