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Household Risk Management and Optimal Mortgage Choice

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  • Joao Cocco
  • John Campbell

Abstract

This paper asks how a household should choose between a fixed-rate (FRM) and an adjustable-rate (ARM) mortgage. In an environment with uncertain inflation a nominal FRM has a risky real capital value, whereas an ARM has a stable real capital value but short-term variability in required real payments. Numerical solution of a life-cycle model with borrowing constraints and income risk shows that an ARM is generally attractive, but less so for a risk-averse household with a large mortgage, risky income, high default cost, or low moving probability. An inflation-indexed FRM can improve substantially on standard nominal mortgages. © 2001 the President and Fellows of Harvard College and the Massachusetts Institute of Technology

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Bibliographic Info

Paper provided by Econometric Society in its series Econometric Society 2004 North American Winter Meetings with number 646.

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Date of creation: 11 Aug 2004
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Handle: RePEc:ecm:nawm04:646

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Keywords: Housing;

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