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Fixed rate mortgages: The cost of interest rate risk aversion

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  • Ahn, Kwangwon
  • Forsyth, Joetta
  • Jang, Hanwool
  • Kim, Dongshin

Abstract

Mortgages play a significant role in the US economy. Americans predominantly use fixed-rate mortgages (FRMs) to avoid interest rate risk, but the related risk aversion cost has not been analyzed yet. This paper fills the gap by investigating the cost of choosing FRMs over adjustable-rate mortgages (ARMs). We find that ex post, FRM borrowers made 12% – 23% higher payments to avoid 0.66% – 1.62% potential ARM payment shocks. Consequently, we introduce and analyze a payment-saving strategy to absorb ARM payment shocks. Emerging data show that ARM borrowers are less financially constrained and less of a concern to policymakers.

Suggested Citation

  • Ahn, Kwangwon & Forsyth, Joetta & Jang, Hanwool & Kim, Dongshin, 2022. "Fixed rate mortgages: The cost of interest rate risk aversion," Finance Research Letters, Elsevier, vol. 44(C).
    • Handle: RePEc:eee:finlet:v:44:y:2022:i:c:s1544612321002373
    DOI: 10.1016/j.frl.2021.102158
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    References listed on IDEAS

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    More about this item

    Keywords

    Mortgage; Interest rate risk; Risk aversion;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G51 - Financial Economics - - Household Finance - - - Household Savings, Borrowing, Debt, and Wealth

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