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Discussion Paper Details

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Title: What Calls to ARMs? International Evidence on Interest Rates and the Choice of Adjustable Rate Mortgages

Author(s): Cristian Badarinza, John Y Campbell and Tarun Ramadorai

Publication Date: August 2014

Keyword(s): adjustable-rate, fixed-rate, household finance, interest rate, international and mortgage choice

Programme Area(s): Financial Economics and International Macroeconomics

Abstract: The relative popularity of adjustable-rate mortgages (ARMs) and fixed-rate mortgages (FRMs) varies considerably both across countries and over time. We ask how movements in current and expected future interest rates affect the share of ARMs in total mortgage issuance. Using a nine-country panel and instrumental variables methods, we present evidence that near-term (one-year) rational expectations of future movements in ARM rates do affect mortgage choice, particularly in more recent data since 2001. However longer-term (three-year) rational forecasts of ARM rates have a weaker effect, and the current spread between FRM and ARM rates also matters, suggesting that households are concerned with current interest costs as well as with lifetime cost minimization. These conclusions are robust to alternative (adaptive and survey-based) models of household expectations.

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Bibliographic Reference

Badarinza, C, Campbell, J and Ramadorai, T. 2014. 'What Calls to ARMs? International Evidence on Interest Rates and the Choice of Adjustable Rate Mortgages'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=10117