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Mortgages as recursive contracts

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Author Info
John Krainer
Milton H. Marquis

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Abstract

Mortgages are one-sided contracts under which the borrower may terminate the contract at any time, while the lender must commit to honoring the terms of the contract throughout its life. There are two aspects to this feature of the contract that are modeled in this paper. The first is that the borrower may choose between buying a house or renting. Given these alternatives, a contract between a household and a lender makes home ownership feasible, and provides insurance to the household against fluctuating rental payments. The second is that once in a contract, the household may terminate the contract by refinancing the future mortgage, and thus enter into a new contract. This option will be exercised whenever a combination of house price appreciation and declines in the mortgage rate is sufficient to increase the ex ante expected lifetime utility from the new versus the old contract.

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Paper provided by Federal Reserve Bank of San Francisco in its series Working Papers in Applied Economic Theory with number 2003-03.

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Date of creation: 2003
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Handle: RePEc:fip:fedfap:2003-03

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Keywords: Mortgage loans ; Mortgages ; Contracts;

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This paper has been announced in the following NEP Reports: References listed on IDEAS
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.:
  1. Glenn Canner & Karen Dynan & Wayne Passmore, 2002. "Mortgage refinancing in 2001 and early 2002," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Dec, pages 469-481. [Downloadable!]
  2. Monika Piazzesi & Martin Schneider & Selale Tuzel, 2004. "Housing, Consumption and Asset Pricing," 2004 Meeting Papers 357c, Society for Economic Dynamics.
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  3. Davis, Morris & Heathcote, Jonathan, 2001. "Housing and the Business Cycle," Working Papers 01-09, Duke University, Department of Economics. [Downloadable!]
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  4. Hanno Lustig & Stijn Van Nieuwerburgh, 2002. "Housing Collateral, Consumption Insurance and Risk Premia," Macroeconomics 0211008, EconWPA. [Downloadable!]
  5. Dunn, Kenneth B & Singleton, Kenneth J, 1983. " An Empirical Analysis of the Pricing of Mortgage-Backed Securities," Journal of Finance, American Finance Association, vol. 38(2), pages 612-23, May.
  6. Patric H. Hendershott, 1980. "Real User Costs and the Demand for Single-Family Housing," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 11(1980-2), pages 401-452. [Downloadable!]
  7. Dunn, Kenneth B & Spatt, Chester S, 1985. " An Analysis of Mortgage Contracting: Prepayment Penalties and the Due-on-Sale Clause," Journal of Finance, American Finance Association, vol. 40(1), pages 293-308, March. [Downloadable!] (restricted)
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  1. Calza, Alessandro & Monacelli, Tommaso & Stracca, Livio, 2007. "Mortgage Markets, Collateral Constraints, and Monetary Policy: Do Institutional Factors Matter?," CEPR Discussion Papers 6231, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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