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On Bank Pricing of Single-family Residential Home Loans: Are Australian Households Paying Too Much?​

James Shilling () and Piyush Tiwari ()
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James Shilling: DePaul University

No GRU_2021_023, GRU Working Paper Series from City University of Hong Kong, Department of Economics and Finance, Global Research Unit

Abstract: This paper focuses on understanding the observed differences in interest rates on single-family residential mortgages during September 2008 to December 2017. Exploiting the conceptual difference in risks associated with fixed rate and variable rate mortgages for lenders, we construct a synthetic variable rate. Synthetic variables are obtained from 3-year fixed rates by adjusting them for interest rate risks premium and call options that are embedded in fixed rates. Estimated error correction model for the difference between actual and synthetic mortgage rate reveals that the unbiasedness hypothesis is rejected and that the lenders in pricing actual variable rates have attached a risk premia of 90 to 150 basis points over synthetic rates. This requires further investigation into institutional arrangements, market structures, underwriting and lending practices of banks as these remain unexplained.

Keywords: mortgage rate differences; swaps; swaptions; errors-in-variables (search for similar items in EconPapers)
JEL-codes: G21 (search for similar items in EconPapers)
Pages: 33
Date: 2021-05-24
New Economics Papers: this item is included in nep-ban and nep-ure
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https://www.cb.cityu.edu.hk/ef/doc/GRU/WPS/GRU%232021-023%20Tiwari.pdf (application/pdf)

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