Fixed rate mortgages: The cost of interest rate risk aversion

Kwangwon Ahn; Joetta Forsyth; Hanwool Jang; Dongshin Kim

doi:10.1016/j.frl.2021.102158

Fixed rate mortgages: The cost of interest rate risk aversion

Kwangwon Ahn, Joetta Forsyth, Hanwool Jang, Dongshin Kim

Department of Industrial Engineering

Research output: Contribution to journal › Article › peer-review

1 Citation (Scopus)

Abstract

Mortgages play a significant role in the US economy. Americans predominantly use fixed-rate mortgages (FRMs) to avoid interest rate risk, but the related risk aversion cost has not been analyzed yet. This paper fills the gap by investigating the cost of choosing FRMs over adjustable-rate mortgages (ARMs). We find that ex post, FRM borrowers made 12% – 23% higher payments to avoid 0.66% – 1.62% potential ARM payment shocks. Consequently, we introduce and analyze a payment-saving strategy to absorb ARM payment shocks. Emerging data show that ARM borrowers are less financially constrained and less of a concern to policymakers.

Original language	English
Article number	102158
Journal	Finance Research Letters
Volume	44
DOIs	https://doi.org/10.1016/j.frl.2021.102158
Publication status	Published - 2022 Jan

Bibliographical note

Funding Information:
Financial support from Yonsei University through the Future-leading Research Initiative (Grant Number: 2020-22-0510 ; Ahn) and from Basic Science Research Program through the National Research Foundation of Korea ( 2020R1A6A3A01100683 ; Jang) are gratefully acknowledged. We thank Peter Chinloy and Stef Schildermans, 2019 AREUEA international conference attendees, and Yunqi Zhang, 2019 AsRES conference attendees, for many helpful suggestions in the early stages of this research.

Publisher Copyright:
© 2021 Elsevier Inc.

All Science Journal Classification (ASJC) codes

Finance

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10.1016/j.frl.2021.102158

Cite this

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title = "Fixed rate mortgages: The cost of interest rate risk aversion",

abstract = "Mortgages play a significant role in the US economy. Americans predominantly use fixed-rate mortgages (FRMs) to avoid interest rate risk, but the related risk aversion cost has not been analyzed yet. This paper fills the gap by investigating the cost of choosing FRMs over adjustable-rate mortgages (ARMs). We find that ex post, FRM borrowers made 12% – 23% higher payments to avoid 0.66% – 1.62% potential ARM payment shocks. Consequently, we introduce and analyze a payment-saving strategy to absorb ARM payment shocks. Emerging data show that ARM borrowers are less financially constrained and less of a concern to policymakers.",

author = "Kwangwon Ahn and Joetta Forsyth and Hanwool Jang and Dongshin Kim",

note = "Funding Information: Financial support from Yonsei University through the Future-leading Research Initiative (Grant Number: 2020-22-0510 ; Ahn) and from Basic Science Research Program through the National Research Foundation of Korea ( 2020R1A6A3A01100683 ; Jang) are gratefully acknowledged. We thank Peter Chinloy and Stef Schildermans, 2019 AREUEA international conference attendees, and Yunqi Zhang, 2019 AsRES conference attendees, for many helpful suggestions in the early stages of this research. Publisher Copyright: {\textcopyright} 2021 Elsevier Inc.",

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N1 - Funding Information: Financial support from Yonsei University through the Future-leading Research Initiative (Grant Number: 2020-22-0510 ; Ahn) and from Basic Science Research Program through the National Research Foundation of Korea ( 2020R1A6A3A01100683 ; Jang) are gratefully acknowledged. We thank Peter Chinloy and Stef Schildermans, 2019 AREUEA international conference attendees, and Yunqi Zhang, 2019 AsRES conference attendees, for many helpful suggestions in the early stages of this research. Publisher Copyright: © 2021 Elsevier Inc.

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N2 - Mortgages play a significant role in the US economy. Americans predominantly use fixed-rate mortgages (FRMs) to avoid interest rate risk, but the related risk aversion cost has not been analyzed yet. This paper fills the gap by investigating the cost of choosing FRMs over adjustable-rate mortgages (ARMs). We find that ex post, FRM borrowers made 12% – 23% higher payments to avoid 0.66% – 1.62% potential ARM payment shocks. Consequently, we introduce and analyze a payment-saving strategy to absorb ARM payment shocks. Emerging data show that ARM borrowers are less financially constrained and less of a concern to policymakers.

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Fixed rate mortgages: The cost of interest rate risk aversion

Abstract

Bibliographical note

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