Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/153885
Authors: 
Corradin, Stefano
Year of Publication: 
2012
Series/Report no.: 
ECB Working Paper 1452
Abstract: 
I propose a life-cycle model where a finitely lived risk averse agent finances her housing investment choosing to provide a down payment. After signing the mortgage contract, the agent may strategically default and move into the rental market. Risk neutral lenders efficiently price mortgages charging a default premium to compensate themselves for expected losses due to default on a mortgage. As a result, mortgage value and amount of leverage are closely linked. An alternative is for the agent to rent the same house, paying a rent fully adjustable to house prices. The rent risk premium is set such that the agent is indifferent ex ante between owning with a mortgage and renting. Three main results arise. First, the optimal down payment and the house price volatility are positively related. The higher the house price volatility, the higher the down payment the agent provides to decrease the volatility of the equity share in the house. Second, in the presence of borrowing constraints, a higher risk of unemployment persistence and/or a substantial drop in labor income decreases the leveraged position the agent takes. Third, ruling out the effect of taking costly leverage on owning a house significantly biases the results in favor of owning over renting.
Subjects: 
Default premium
loan to income ratio and
loan to value ratio
negative home equity
rent risk premium
JEL: 
G21
E21
Document Type: 
Working Paper

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