Fixed rate mortgages: The cost of interest rate risk aversion

Kwangwon Ahn, Joetta Forsyth, Hanwool Jang and Dongshin Kim

Finance Research Letters, 2022, vol. 44, issue C

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.

Keywords: Mortgage; Interest rate risk; Risk aversion (search for similar items in EconPapers)
JEL-codes: G21 G51 (search for similar items in EconPapers)
Date: 2022
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:finlet:v:44:y:2022:i:c:s1544612321002373

DOI: 10.1016/j.frl.2021.102158

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