The optimal LTV-ratio, mortgage market variability and monetary policy regimes

Trond Arne Borgersen

Journal of Financial Economic Policy, 2017, vol. 9, issue 02, 225-239

Abstract: Purpose - The purpose of this paper is twofold: first, it derives the optimal loan-to-value (LTV)-ratio for a mortgagor that maximizes the return to home equity when considering the capital structure of housing investment. Second, it analyses the demand-side contribution to mortgage market variability across monetary policy regimes. Design/methodology/approach - The paper endogenizes both the relation between the LTV ratio and the mortgage rate and the relation between LTV and the rate of appreciation. When we consider LTV-variance and the demand-side contribution to mortgage market variability, three stylized regimes is considered. Findings - The paper finds an intuitive ranking of the optimal LTV-ratios across regimes, and the optimal LTV-ratio peaks during a housing boom. When, however, monetary policy ignores asset inflation the demand-side contribution to market variability is highest during normal market conditions. Hence, there is a potentially hump-shaped relation between the risk exposure of individual mortgagors and the demand-side contribution to mortgage market variability. Originality/value - The paper finds a potentially hump-shaped relation between the risk exposure of individual mortgagors and the demand-side contribution to mortgage market variability, which, to the best of our knowledge, is novel. The paper shows how macro-prudential and monetary policy are complementary tolls for preserving financial stability.

Keywords: Monetary policy; Housing supply and markets; Mortgage market variability and monetary policy strategy; LTV-ratio; Housing appreciation; Mortgage rates; C32; G15; F3 (search for similar items in EconPapers)
Date: 2017
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Persistent link: https://EconPapers.repec.org/RePEc:eme:jfeppp:jfep-06-2016-0044

DOI: 10.1108/JFEP-06-2016-0044

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