AbstractI propose a life-cycle model where a finitely lived risk averse agent finances her housing investment choosing to provide a down payment. After signing the mortgage contract, the agent may strategically default and move into the rental market. Risk neutral lenders efficiently price mortgages charging a default premium to compensate themselves for expected losses due to default on a mortgage. As a result, mortgage value and amount of leverage are closely linked. An alternative is for the agent to rent the same house, paying a rent fully adjustable to house prices. The rent risk premium is set such that the agent is indifferent ex ante between owning with a mortgage and renting. Three main results arise. First, the optimal down payment and the house price volatility are positively related. The higher the house price volatility, the higher the down payment the agent provides to decrease the volatility of the equity share in the house. Second, in the presence of borrowing constraints, a higher risk of unemployment persistence and/or a substantial drop in labor income decreases the leveraged position the agent takes. Third, ruling out the effect of taking costly leverage on owning a house significantly biases the results in favor of owning over renting. JEL Classification: G21, E21
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by European Central Bank in its series Working Paper Series with number 1452.
Date of creation: Jul 2012
Date of revision:
Contact details of provider:
Postal: Postfach 16 03 19, Frankfurt am Main, Germany
Phone: +49 69 1344 0
Fax: +49 69 1344 6000
Web page: http://www.ecb.europa.eu/home/html/index.en.html
More information through EDIRC
Postal: Press and Information Division, European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany
Other versions of this item:
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
- E21 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-09-16 (All new papers)
- NEP-BAN-2012-09-16 (Banking)
- NEP-DGE-2012-09-16 (Dynamic General Equilibrium)
- NEP-URE-2012-09-16 (Urban & Real Estate Economics)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Gourinchas, Pierre-Olivier & Parker, Jonathan A, 2000.
"Consumption Over the Life-Cycle,"
CEPR Discussion Papers
2345, C.E.P.R. Discussion Papers.
- John Y. Campbell & Joao F. Cocco, 2003.
"Household Risk Management and Optimal Mortgage Choice,"
NBER Working Papers
9759, National Bureau of Economic Research, Inc.
- John Y. Campbell & Joao F. Cocco, 2003. "Household Risk Management And Optimal Mortgage Choice," The Quarterly Journal of Economics, MIT Press, vol. 118(4), pages 1449-1494, November.
- Campbell, John & Cocco, Joao, 2003. "Household Risk Management and Optimal Mortgage Choice," Scholarly Articles 3157876, Harvard University Department of Economics.
- Joao Cocco & John Campbell, 2004. "Household Risk Management and Optimal Mortgage Choice," Econometric Society 2004 North American Winter Meetings 646, Econometric Society.
- John Campbell & Joao F. Cocco, 2002. "Household Risk Management and Optimal Mortgage Choice," Computing in Economics and Finance 2002 47, Society for Computational Economics.
- Joao Cocco & John Campbell, 2004. "Household Risk Management and Optimal Mortgage Choice," Econometric Society 2004 North American Winter Meetings 632, Econometric Society.
- John Y. Campbell & Joao F. Cocco, 2002. "Household Risk Management and Optimal Mortgage Choice," Harvard Institute of Economic Research Working Papers 1946, Harvard - Institute of Economic Research.
- Andra C. Ghent & Marianna Kudlyak, 2011. "Recourse and Residential Mortgage Default: Evidence from US States 1," Review of Financial Studies, Society for Financial Studies, vol. 24(9), pages 3139-3186.
- Todd Sinai & Nicholas S. Souleles, 2005.
"Owner-Occupied Housing as a Hedge Against Rent Risk,"
The Quarterly Journal of Economics,
MIT Press, vol. 120(2), pages 763-789, May.
- Todd Sinai & Nicholas S. Souleles, 2003. "Owner-Occupied Housing as a Hedge Against Rent Risk," NBER Working Papers 9462, National Bureau of Economic Research, Inc.
- Todd Sinai & Nicholas S. Souleles, 2005. "Owner-occupied housing as a hedge against rent risk," Working Papers 05-10, Federal Reserve Bank of Philadelphia.
- Foote, Christopher L. & Gerardi, Kristopher & Willen, Paul S., 2008.
"Negative equity and foreclosure: Theory and evidence,"
Journal of Urban Economics,
Elsevier, vol. 64(2), pages 234-245, September.
- Christopher L. Foote & Kristopher Gerardi & Paul S. Willen, 2008. "Negative equity and foreclosure: theory and evidence," Public Policy Discussion Paper 08-3, Federal Reserve Bank of Boston.
- Deaton, A., 1989.
"Saving And Liquidity Constraints,"
153, Princeton, Woodrow Wilson School - Public and International Affairs.
- John Y. Campbell & Stefano Giglio & Parag Pathak, 2009.
"Forced Sales and House Prices,"
NBER Working Papers
14866, National Bureau of Economic Research, Inc.
- Jaffee, Dwight M. & Quigley, John M., 2007. "Housing Subsidies and Homeowners: What Role for Government-Sponsored Enterprises?," Berkeley Program on Housing and Urban Policy, Working Paper Series qt6g8986r5, Berkeley Program on Housing and Urban Policy.
- Ortalo-Magne, Francois & Rady, Sven, 2002. "Tenure choice and the riskiness of non-housing consumption," Journal of Housing Economics, Elsevier, vol. 11(3), pages 266-279, September.
- Corradin, Stefano & Fillat, Jose L. & Vergara, Carles, 2012.
"Optimal portfolio choice with predictability in house prices and transaction costs,"
IESE Research Papers
D/948, IESE Business School.
- Corradin, Stefano & Fillat, José L. & Vergara-Alert, Carles, 2012. "Optimal portfolio choice with predictability in house prices and transaction costs," Working Paper Series 1470, European Central Bank.
- Stefano Corradin & José L. Fillat & Carles Vergara-Alert, 2010. "Optimal portfolio choice with predictability in house prices and transaction costs," Risk and Policy Analysis Unit Working Paper QAU10-2, Federal Reserve Bank of Boston.
- Henderson, J Vernon & Ioannides, Yannis M, 1983. "A Model of Housing Tenure Choice," American Economic Review, American Economic Association, vol. 73(1), pages 98-113, March.
- Joao F. Cocco, 2005. "Portfolio Choice in the Presence of Housing," Review of Financial Studies, Society for Financial Studies, vol. 18(2), pages 535-567.
- Munk, Claus, 2000. "Optimal consumption/investment policies with undiversifiable income risk and liquidity constraints," Journal of Economic Dynamics and Control, Elsevier, vol. 24(9), pages 1315-1343, August.
- Benjamin J. Keys & Tanmoy Mukherjee & Amit Seru & Vikrant Vig, 2010. "Did Securitization Lead to Lax Screening? Evidence from Subprime Loans," The Quarterly Journal of Economics, MIT Press, vol. 125(1), pages 307-362, February.
- Nikolai Roussanov & Michael Michaux & Hui Chen, 2011. "Houses as ATMs? Mortgage Refinancing and Macroeconomic Uncertainty," 2011 Meeting Papers 1369, Society for Economic Dynamics.
- Kau James B. & Keenan Donald C. & Kim Taewon, 1994. "Default Probabilities for Mortgages," Journal of Urban Economics, Elsevier, vol. 35(3), pages 278-296, May.
- Kau, James B, et al, 1992. "A Generalized Valuation Model for Fixed-Rate Residential Mortgages," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 24(3), pages 279-99, August.
- Cox, John C. & Ross, Stephen A., 1976. "The valuation of options for alternative stochastic processes," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 145-166.
- Thomas Schelkle, 2012. "Mortgage Default during the U.S. Mortgage Crisis," 2012 Meeting Papers 751, Society for Economic Dynamics.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Official Publications).
If references are entirely missing, you can add them using this form.