Mortgage-rate pass-through in the presence of refinancing

David Berger, Fabrice Tourre and Konstantin Milbradt
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Fabrice Tourre: Northwestern University
Konstantin Milbradt: Northwestern University

No 1097, 2018 Meeting Papers from Society for Economic Dynamics

Abstract: We present an analytically tractable model of the mortgage-rate pass through and the cross-section of coupon rates in the economy. Competitive banks offer downward adjustable fixed-rate risk-free mortgages (“refinancing”) with current mortgage rate m(r) where r is the prevailing short-rate the bank uses to finance the mortgage. We present two versions: (1) Rational attentive investors facing small adjustment cost refinance as soon as the current mortgage rate is below their individual mortgage rate; (2) rational inattentive consumers facing small adjustment cost refinance as soon as they become aware of the current mortgage rate being below their individual mortgage rate. We analytically derive m(r) for general processes and the ergodic distribution of mortgage rates in the economy. The mortgage rate function m(r) is increasing and additionally concave. Thus, monetary policy has a differential impact on the housing market depending on the level of the interest rate r. Further, the mortgage pass-through is affected by default risk, financial literacy, and the competitiveness of the banking industry.

Date: 2018
New Economics Papers: this item is included in nep-ban, nep-fle and nep-ure
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