Mortgage Design in an Equilibrium Model of the Housing Market

Adam Guren, Arvind Krishnamurthy and Timothy J. McQuade

Journal of Finance, 2021, vol. 76, issue 1, 113-168

Abstract: How can mortgages be redesigned to reduce macrovolatility and default? We address this question using a quantitative equilibrium life‐cycle model. Designs with countercyclical payments outperform fixed payments. Among those, designs that front‐load payment reductions in recessions outperform those that spread relief over the full term. Front‐loading alleviates liquidity constraints when they bind most, reducing default and stimulating housing demand. To illustrate, a fixed‐rate mortgage (FRM) with an option to convert to adjustable‐rate mortgage, which front‐loads payment reductions relative to an FRM with an option to refinance underwater, reduces price and consumption declines six times as much and default three times as much.

Date: 2021
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https://doi.org/10.1111/jofi.12963

Related works:
Working Paper: Mortgage Design in an Equilibrium Model of the Housing Market (2018)
Working Paper: Mortgage Design in an Equilibrium Model of the Housing Market (2016)
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Persistent link: https://EconPapers.repec.org/RePEc:bla:jfinan:v:76:y:2021:i:1:p:113-168

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