Systemic risk and the refinancing ratchet effect

Amir E. Khandani, Andrew Lo () and Robert Merton

Journal of Financial Economics, 2013, vol. 108, issue 1, 29-45

Abstract: The combination of rising home prices, declining interest rates, and near-frictionless refinancing opportunities can create unintentional synchronization of homeowner leverage, leading to a “ratchet” effect on leverage because homes are indivisible and owner-occupants cannot raise equity to reduce leverage when home prices fall. Our simulation of the U.S. housing market yields potential losses of $1.7 trillion from June 2006 to December 2008 with cash-out refinancing vs. only $330 billion in the absence of cash-out refinancing. The refinancing ratchet effect is a new type of systemic risk in the financial system and does not rely on any dysfunctional behaviors.

Keywords: Systemic risk; Financial crisis; Household finance; Real estate; Subprime mortgage (search for similar items in EconPapers)
JEL-codes: E17 G01 G13 G18 G21 R28 (search for similar items in EconPapers)
Date: 2013
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Citations: View citations in EconPapers (35)

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Related works:
Working Paper: Systemic Risk and the Refinancing Ratchet Effect (2010)
Working Paper: Systemic Risk and the Refinancing Ratchet Effect (2009)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:108:y:2013:i:1:p:29-45

DOI: 10.1016/j.jfineco.2012.10.007

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