The Demand and Supply of Mortgage Fixation Periods. Managing Interest Rate Risk and Credit Risk in a Low Rate Environment

Abstract

We examine the determinants of households' and banks' choice of mortgage rate fixation periods (FP) in a low interest rate environment. The existing literature interprets equilibrium FP, often reduced to the choice between Fixed Rate Mortgages (FRM) and Adjustable Rate Mortgages (ARM), as purely demand driven. Using a unique dataset with offers from multiple banks for each mortgage request, we are the first to explicitly disentangle demand and supply determinants of FP choices. We show that banks can advance their own FP preferences along several dimensions. Their desired FP must account both for the implied Interest Rate Risk (IRR), and for the Credit Risk implications from shifting that IRR to households. Our empirical results confirm that banks do indeed take into account both types of risk, although some margins of response are used only to small extent.