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Fixed Rate or Index-Linked Mortgages from the Borrower's Point of View: A Note

Published online by Cambridge University Press:  06 April 2009

Meir Statman
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Extract

When will borrowers choose fixed rate mortgages and when will they prefer index-linked mortgages? Baesel and Biger (BB) [1] proposed a model that answers this question. According to the BB model, a borrower's preference depends on the difference in interest rates between the fixed and index-linked mortgages, and on the covariance between the borrower's labor income and the rate of inflation. The purpose of this note is to propose a more complete model of borrower preferences. The novelty of the model lies in the inclusion of the value of the house (net of mortgage obligation) in the terminal wealth of the borrower. This inclusion leads to differences between this model and the BB model in the identification of the cases where borrowers will prefer fixed or index-linked mortgages.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 17 , Issue 3 , September 1982 , pp. 451 - 457
Copyright
Copyright © School of Business Administration, University of Washington 1982

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References

[l]Baesel, Jerome B., and Biger, Nahum. “The Allocation of Risk: Some Implications of Fixed versus Index-Linked Mortgages.” Joiamal of Financial and Quantitative Analysis, Vol. 15, No. 2 (06 1980), pp. 457–468.CrossRefGoogle Scholar
[2]Thaler, Richard H., and Shefrin, H. M.. “An Economic Theory of Self-Control.” Journal of Political Economy, Vol. 89, No. 2 (04 1981), pp. 392–410.CrossRefGoogle Scholar