How Do Banks and Households Manage Interest Rate Risk? Evidence from Mortgage Applications and Banks’ Responses

Abstract

We exploit a unique dataset that features both un-intermediated mortgage requests and independent responses from multiple banks to each request. We show that households typically are not prudent risk managers, but prioritize minimizing current mortgage payments over insurance against future rate increases. Contrary to assumptions in the previous literature, we find that banks do also influence contracted rate fixation periods. They trade off their own exposure to interest rate risk against household requests and against credit risk.

Keywords: Interest rate risk, credit risk, maturity mismatch, duration, fixation period, repricing frequency, fixed-rate mortgage, adjustable rate mortgage

JEL Classification: D14, E43, G21