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On Bank Pricing of Single-family Residential Home Loans: Are Australian Households Paying Too Much?​

Author

Listed:
  • James D. Shilling

    (DePaul University)

  • Piyush Tiwari

    (University of Melbourne)

Abstract

This paper focuses on understanding the observed differences in interest rates on single-family residential mortgages during September 2008 to December 2017. Exploiting the conceptual difference in risks associated with fixed rate and variable rate mortgages for lenders, we construct a synthetic variable rate. Synthetic variables are obtained from 3-year fixed rates by adjusting them for interest rate risks premium and call options that are embedded in fixed rates. Estimated error correction model for the difference between actual and synthetic mortgage rate reveals that the unbiasedness hypothesis is rejected and that the lenders in pricing actual variable rates have attached a risk premia of 90 to 150 basis points over synthetic rates. This requires further investigation into institutional arrangements, market structures, underwriting and lending practices of banks as these remain unexplained.

Suggested Citation

  • James D. Shilling & Piyush Tiwari, 2021. "On Bank Pricing of Single-family Residential Home Loans: Are Australian Households Paying Too Much?​," GRU Working Paper Series GRU_2021_023, City University of Hong Kong, Department of Economics and Finance, Global Research Unit.
    • Handle: RePEc:cth:wpaper:gru_2021_023
    as

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    File URL: https://www.cb.cityu.edu.hk/ef/doc/GRU/WPS/GRU%232021-023%20Tiwari.pdf
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    mortgage rate differences; swaps; swaptions; errors-in-variables;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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