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Risky Mortgages in a DSGE Model

Author

Listed:
  • Chiara Forlati

    (Chair of International Finance, Ecole Polytechnique Federale de Lausanne (EPFL), Switzerland)

  • Luisa Lambertini

    (Chair of International Finance, Ecole Polytechnique Federale de Lausanne (EPFL), Switzerland)

Abstract

This paper develops a DSGE model with housing, risky mortgages and endogenous default. Housing investment is subject to idiosyncratic risk and some mortgages are defaulted in equilibrium. An unanticipated increase in the standard deviation of housing investment produces a credit crunch where delinquencies and mortgage interest rates increase, lending is curtailed, and aggregate demand for non-durable goods falls. The economy experiences a recession as a consequence of the credit crunch. The paper compares economies that differ only in the riskiness of housing investment. Economies with lower risk are characterized by lower steady-state mortgage default rates and higher loan-to-value and leverage ratios. The macroeconomic effects of an unanticipated increase in housing investment risk are amplified in high-leverage economies. Monetary policy plays an important role in the transmission of housing investment risk, as inertial interest rate rules generate deeper output contractions.

Suggested Citation

  • Chiara Forlati & Luisa Lambertini, 2010. "Risky Mortgages in a DSGE Model," Working Papers 201002, Center for Fiscal Policy, Swiss Federal Institute of Technology Lausanne, revised Nov 2010.
    • Handle: RePEc:cif:wpaper:201002
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    References listed on IDEAS

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    More about this item

    Keywords

    Housing; Mortgage default; Mortgage Risk;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G01 - Financial Economics - - General - - - Financial Crises
    • 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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