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Household Risk Management and Optimal Mortgage Choice

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  • John Campbell
  • Joao F. Cocco

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.
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(This abstract was borrowed from another version of this item.)

Suggested Citation

  • John Campbell & Joao F. Cocco, 2002. "Household Risk Management and Optimal Mortgage Choice," Computing in Economics and Finance 2002 47, Society for Computational Economics.
    • Handle: RePEc:sce:scecf2:47
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    More about this item

    Keywords

    Mortgage Choice; Interest Rate Risk; Borrowing Constraints; Non-tradable Income;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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