55 Pages Posted: 15 Mar 2006 Last revised: 23 Feb 2009
Date Written: February 1, 2009
I investigate household interest rate risk management by solving a life-cycle asset allocation model that includes mortgage and bond portfolio choice. I find that most investors prefer an adjustable-rate mortgage, and thereby save on the bond risk premium that is contained in fixed-rate mortgage payments. Only older, risk-averse investors hold some fixed-rate mortgage debt. Together with a position in short-term bonds this enables them to hedge against changes in the real interest rate, while the inflation exposure of the debt and bond positions cancel out. Hedging house price changes with bonds only occurs at the end of the life cycle. Early in the life cycle short-sale constraints prevent an effective hedge.
Keywords: portfolio choice, mortgage, housing, term structure of interest rates
JEL Classification: G11, E43
Suggested Citation: Suggested Citation
Van Hemert, Otto, Household Interest Rate Risk Management (February 1, 2009). AFA 2007 Chicago Meetings Paper; EFA 2006 Zurich Meetings. Available at SSRN: https://ssrn.com/abstract=891034 or http://dx.doi.org/10.2139/ssrn.891034