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Risky Mortgages in a DSGE Model

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  • Chiara Forlati

    ()
    (Chair of International Finance, Ecole Polytechnique Federale de Lausanne (EPFL), Switzerland)

  • Luisa Lambertini

    ()
    (Chair of International Finance, Ecole Polytechnique Federale de Lausanne (EPFL), Switzerland)

Abstract

This paper develops a DSGE model with housing, risky mortgages and endogenous default. Housing investment is subject to idiosyncratic risk and some mortgages are defaulted in equilibrium. An unanticipated increase in the standard deviation of housing investment produces a credit crunch where delinquencies and mortgage interest rates increase, lending is curtailed, and aggregate demand for non-durable goods falls. The economy experiences a recession as a consequence of the credit crunch. The paper compares economies that differ only in the riskiness of housing investment. Economies with lower risk are characterized by lower steady-state mortgage default rates and higher loan-to-value and leverage ratios. The macroeconomic effects of an unanticipated increase in housing investment risk are amplified in high-leverage economies. Monetary policy plays an important role in the transmission of housing investment risk, as inertial interest rate rules generate deeper output contractions.

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Bibliographic Info

Paper provided by Center for Fiscal Policy, Swiss Federal Institute of Technology Lausanne in its series Working Papers with number 201002.

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Length: 49 pages
Date of creation: Nov 2010
Date of revision: Nov 2010
Handle: RePEc:cif:wpaper:201002

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Keywords: Housing; Mortgage default; Mortgage Risk;

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  1. Bernanke, Ben S. & Gertler, Mark & Gilchrist, Simon, 1999. "The financial accelerator in a quantitative business cycle framework," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 21, pages 1341-1393 Elsevier.
  2. Matteo Iacoviello, 2002. "House prices, borrowing constraints and monetary policy in the business cycle," Boston College Working Papers in Economics 542, Boston College Department of Economics, revised 06 Dec 2004.
  3. Aoki, Kosuke & James Proudman & Gertjan Vlieghe, 2003. "House prices, consumption, and monetary policy: a financial accelerator approach," Royal Economic Society Annual Conference 2003 7, Royal Economic Society.
  4. Carlstrom, Charles T & Fuerst, Timothy S, 1997. "Agency Costs, Net Worth, and Business Fluctuations: A Computable General Equilibrium Analysis," American Economic Review, American Economic Association, vol. 87(5), pages 893-910, December.
  5. Calza, Alessandro & Stracca, Livio & Monacelli, Tommaso, 2009. "Housing finance and monetary policy," Working Paper Series 1069, European Central Bank.
  6. Tommaso Monacelli & Ester Faia, 2005. "Optimal Interest Rate Rules, Asset Prices and Credit Frictions," Computing in Economics and Finance 2005 452, Society for Computational Economics.
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Cited by:
  1. Bofinger, Peter & Debes, Sebastian & Gareis, Johannes & Mayer, Eric, 2013. "Monetary policy transmission in a model with animal spirits and house price booms and busts," Journal of Economic Dynamics and Control, Elsevier, vol. 37(12), pages 2862-2881.
  2. Dominic Quint & Pau Rabanal, 2013. "Monetary and Macroprudential Policy in an Estimated DSGE Model of the Euro Area," IMF Working Papers 13/209, International Monetary Fund.
  3. PIROVANO, Mara, 2013. "Household and firm leverage, capital flows and monetary policy in a small open economy," Working Papers 2013014, University of Antwerp, Faculty of Applied Economics.
  4. Chiara Forlati & Luisa Lambertini, 2012. "Mortgage Amortization and Amplification," Working Papers 201201, Center for Fiscal Policy, Swiss Federal Institute of Technology Lausanne, revised Feb 2012.
  5. Eric Mayer & Johannes Gareis, 2013. "What Drives Ireland’s Housing Market? A Bayesian DSGE Approach," Open Economies Review, Springer, vol. 24(5), pages 919-961, November.
  6. M. Falagiarda & A. Saia, 2013. "Credit, Endogenous Collateral and Risky Assets: A DSGE Model," Working Papers wp916, Dipartimento Scienze Economiche, Universita' di Bologna.

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