Quarterly Journal of Economics Vol. 118 No. 4 2003
Household Risk Management and Optimal Mortgage Choice
open access
Abstract
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.
- DOI
- 10.1162/003355303322552847
- Volume
- 118
- Issue
- 4
- Pages
- 1449-1494
- Language
- en
- Sources
- bibtex:phds-export.bib openalex crossref