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What Calls to ARMs? International Evidence on Interest Rates and the Choice of Adjustable Rate Mortgages

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  • Badarinza, Cristian
  • Campbell, John Y
  • Ramadorai, Tarun

Abstract

The relative popularity of adjustable-rate mortgages (ARMs) and fixed-rate mortgages (FRMs) varies considerably both across countries and over time. We ask how movements in current and expected future interest rates affect the share of ARMs in total mortgage issuance. Using a nine-country panel and instrumental variables methods, we present evidence that near-term (one-year) rational expectations of future movements in ARM rates do affect mortgage choice, particularly in more recent data since 2001. However longer-term (three-year) rational forecasts of ARM rates have a weaker effect, and the current spread between FRM and ARM rates also matters, suggesting that households are concerned with current interest costs as well as with lifetime cost minimization. These conclusions are robust to alternative (adaptive and survey-based) models of household expectations.

Suggested Citation

  • Badarinza, Cristian & Campbell, John Y & Ramadorai, Tarun, 2014. "What Calls to ARMs? International Evidence on Interest Rates and the Choice of Adjustable Rate Mortgages," CEPR Discussion Papers 10117, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:10117
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    References listed on IDEAS

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    1. 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.
    2. Tarun Ramadorai, 2012. "The Secondary Market for Hedge Funds and the Closed Hedge Fund Premium," Journal of Finance, American Finance Association, vol. 67(2), pages 479-512, April.
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    Cited by:

    1. Gabriele Foà & Leonardo Gambacorta & Luigi Guiso & Paolo Emilio Mistrulli, 2015. "The Supply Side of Household Finance," EIEF Working Papers Series 1507, Einaudi Institute for Economics and Finance (EIEF), revised Jul 2015.
    2. Matteo Benetton, 2017. "Lenders' Competition and Macro-prudential Regulation: A Model of the UK Mortgage Supermarket," 2017 Meeting Papers 1001, Society for Economic Dynamics.
    3. Michael Richter, 2017. "Asymmetric Effects on Financial Cycles in a Monetary Union with Diverging Country Preferences for Variable- and Fixed-Rate Mortgages," Review of Economics & Finance, Better Advances Press, Canada, vol. 7, pages 19-36, February.
    4. Ákos Aczél & Ádám Banai & András Borsos & Bálint Dancsik, 2016. "Identifying the determinants of housing loan margins in the Hungarian banking system," Financial and Economic Review, Magyar Nemzeti Bank (Central Bank of Hungary), vol. 15(4), pages 5-44.

    More about this item

    Keywords

    adjustable-rate; fixed-rate; household finance; interest rate; international; mortgage choice;

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • N20 - Economic History - - Financial Markets and Institutions - - - General, International, or Comparative
    • R21 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Household Analysis - - - Housing Demand
    • R31 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Real Estate Markets, Spatial Production Analysis, and Firm Location - - - Housing Supply and Markets

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