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Household Risk Management and Optimal Mortgage Choice

Author

Listed:
  • Campbell, John
  • Cocco, Joao
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.

Suggested Citation

  • Campbell, John & Cocco, Joao, 2003. "Household Risk Management and Optimal Mortgage Choice," Scholarly Articles 3157876, Harvard University Department of Economics.
    • Handle: RePEc:hrv:faseco:3157876
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