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Household Risk Management And Optimal Mortgage Choice

  • John Y. Campbell
  • Joao F. Cocco

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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Article provided by MIT Press in its journal The Quarterly Journal of Economics.

Volume (Year): 118 (2003)
Issue (Month): 4 (November)
Pages: 1449-1494

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Handle: RePEc:tpr:qjecon:v:118:y:2003:i:4:p:1449-1494
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