Interest Rate Fixation Periods and Reference Points

Abstract

This paper shows how retail borrowers' focus on recent interest rates as reference points may lead to choices of interest rate fixation periods which are inconsistent with normative predictions. A laboratory experiment reveals that borrowers prefer longer interest rate fixation periods when interest rates have fallen and shorter interest rate fixation periods when interest rates have risen. Normative drivers of interest rate fixation choice related to borrower characteristics, loan attributes, and pricing variables cannot explain these decisions. Market data from a mortgage broker confirms our findings in a context in which sound financial decisions are of prime importance for households’ financial well-being.

Keywords: Behavioral Finance, Experimental Finance, Credit, Mortgages

JEL Classification: G21, D12, D14, C91