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Why Do We Have ARMs?

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  • Jan K. Brueckner

Abstract

This paper suggests a resolution to the paradox of inefficient risk bearing by adjustable-rate mortgage (ARM) borrowers. The analysis shows that when contracts are written in a realistic way, with payments linked across time via a common loan-rate function, risk sharing and the tilt of the mortgage payment stream become inextricably linked. Unless time preferences are identical or the cost of funds exhibits no time trend, borrowers will accept interest-rate risk in order to gain a more favorable time path of mortgage payments. Copyright American Real Estate and Urban Economics Association.

Suggested Citation

  • Jan K. Brueckner, 1993. "Why Do We Have ARMs?," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 21(3), pages 333-345.
  • Handle: RePEc:bla:reesec:v:21:y:1993:i:3:p:333-345
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    File URL: http://www.blackwell-synergy.com/doi/abs/10.1111/1540-6229.00614
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    Cited by:

    1. Sprecher, C. R. & Willman, Elliott, 2000. "The Role of the Initial Discount in the Pricing of Adjustable-Rate Mortgages," Journal of Housing Economics, Elsevier, vol. 9(1-2), pages 64-75, March.
    2. Masaki Mori & Julian Diaz III & Alan J. Ziobrowski, 2009. "Why Do Borrowers Choose Adjustable-Rate Mortgages over Fixed-Rate Mortgages? : A Behavioral Investigation," International Real Estate Review, Asian Real Estate Society, vol. 12(2), pages 98-120.
    3. John Y. Campbell & João F. Cocco, 2003. "Household Risk Management and Optimal Mortgage Choice," The Quarterly Journal of Economics, Oxford University Press, vol. 118(4), pages 1449-1494.
    4. Posey, Lisa L. & Yavas, Abdullah, 2001. "Adjustable and Fixed Rate Mortgages as a Screening Mechanism for Default Risk," Journal of Urban Economics, Elsevier, vol. 49(1), pages 54-79, January.
    5. Yao-Min Chiang & Jarjisu Sa-Aadu, 2014. "Optimal Mortgage Contract Choice Decision in the Presence of Pay Option Adjustable Rate Mortgage and the Balloon Mortgage," The Journal of Real Estate Finance and Economics, Springer, vol. 48(4), pages 709-753, May.
    6. Sumit Agarwal & Brent W. Ambrose, 2008. "Does it pay to read your junk mail? evidence of the effect of advertising on home equity credit choices," Working Paper Series WP-08-09, Federal Reserve Bank of Chicago.

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