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Household Risk Management and Optimal Mortgage Choice

  • John 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.

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Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2002 with number 47.

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Date of creation: 01 Jul 2002
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Handle: RePEc:sce:scecf2:47
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