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Household Interest Rate Risk Management

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  • Otto Van Hemert

Abstract

I investigate household interest rate risk management by solving a life‐cycle asset allocation model that includes mortgage and bond portfolio choice. I find that most investors prefer an adjustable‐rate mortgage and thereby save on the bond risk premium that is contained in fixed‐rate mortgage payments. Only older, risk‐averse investors hold some fixed‐rate mortgage debt. Together with a position in short‐term bonds this enables them to hedge against changes in the real interest rate, while the inflation exposure of the debt and bond positions cancel out. Hedging house price changes with bonds only occurs at the end of the life cycle. Early in the life cycle short‐sale constraints prevent an effective hedge.

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  • Otto Van Hemert, 2010. "Household Interest Rate Risk Management," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 38(3), pages 467-505, September.
    • Handle: RePEc:bla:reesec:v:38:y:2010:i:3:p:467-505
    DOI: 10.1111/j.1540-6229.2010.00274.x
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    4. Roine Vestman, 2019. "Limited Stock Market Participation Among Renters and Homeowners," The Review of Financial Studies, Society for Financial Studies, vol. 32(4), pages 1494-1535.
    5. Cóndor Richard, 2019. "Measuring the cost of U.S. housing policy," Working Papers 2019-08, Banco de México.
    6. Marekwica, Marcel & Schaefer, Alexander & Sebastian, Steffen, 2013. "Life cycle asset allocation in the presence of housing and tax-deferred investing," Journal of Economic Dynamics and Control, Elsevier, vol. 37(6), pages 1110-1125.
    7. Lukas, Moritz & Nöth, Markus, 2021. "Interest rate fixation periods and reference points," Journal of Behavioral and Experimental Economics (formerly The Journal of Socio-Economics), Elsevier, vol. 94(C).
    8. Kraft, Holger & Munk, Claus & Wagner, Sebastian, 2015. "Housing habits and their implications for life-cycle consumption and investment," SAFE Working Paper Series 85, Leibniz Institute for Financial Research SAFE, revised 2015.
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    10. Kraft, Holger & Munk, Claus & Weiss, Farina, 2017. "Predictors and portfolios over the life cycle: Skill vs. luck," SAFE Working Paper Series 139, Leibniz Institute for Financial Research SAFE, revised 2017.
    11. Fischer, Marcel & Kraft, Holger & Munk, Claus, 2013. "Asset allocation over the life cycle: How much do taxes matter?," Journal of Economic Dynamics and Control, Elsevier, vol. 37(11), pages 2217-2240.
    12. Marcel Fischer & Natalia Khorunzhina, 2019. "Housing Decision With Divorce Risk," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 60(3), pages 1263-1290, August.
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    17. Davis, Morris A. & Van Nieuwerburgh, Stijn, 2015. "Housing, Finance, and the Macroeconomy," Handbook of Regional and Urban Economics, in: Gilles Duranton & J. V. Henderson & William C. Strange (ed.), Handbook of Regional and Urban Economics, edition 1, volume 5, chapter 0, pages 753-811, Elsevier.

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