Mortgage Design in an Equilibrium Model of the Housing Market - Working Paper 24446 - March 2018

Sep 4, 2026

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Design mortgages to reduce housing market volatility, consumption volatility, and defaults while accounting for interactions with monetary policy. A quantitative equilibrium life-cycle model with aggregate shocks and long-term mortgages evaluates contracts that index payments to monetary policy. Payment structures that rise in booms and fall in recessions outperform fixed payments, delivering sizable simulated crisis improvements. Front-loading payment reductions in recessions alleviates liquidity constraints, lowering defaults and stimulating housing demand.

LanguageEnglish

CategoryResearch & Report

FormatPDF

Pages70

Reading Time2 h 56 min

AccessFree to download

Introduction

Motivation and evidence

Mortgage design goals

Contract features and payment paths

NBER WORKING PAPER SERIES MORTGAGE DESIGN IN AN EQUILIBRIUM MODEL OF THE HOUSING MARKET Adam M. Guren Arvind Krishnamurthy Timothy J. McQuade Working Paper 24446 [http://www.nber.org/papers/w24446](http://www.nber.org/papers/w24446) NATIONAL BUREAU OF ECONOMIC RESEARCH 1050 Massachusetts Avenue Cambridge, MA 02138 March 2018 The authors would like to thank Chaojun Wang and Xuiyi Song for excellent research assistance and seminar participants at SED, SITE, Kellogg, Queen's, Indiana, LSE, Boston University, HULM, Housing: Micro Data, Macro Problems, NBER Summer Institute Capital Markets and the Economy, CEPR Housing and the Macroeconomy, Chicago Booth Asset Pricing, UCLA, University of Pittsburgh, MIT Sloan, Wharton, the University of Pennsylvania, Tomasz Piskorski, Erwan Quintin, Jan Eberly, Alex Michaelides, Alexei Tchistyi, and Andreas Fuster for useful comments. Guren acknowledges research support from the National Science Foundation under grant \#1623801 and from the Boston University Center for Finance, Law, and Policy. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research. NBER working papers are circulated for discussion and comment purposes. They have not been peerreviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications. © 2018 by Adam M. Guren, Arvind Krishnamurthy, and Timothy J. McQuade. All rights reserved. Short sections of text, not to exceed two paragraphs, may be quoted without explicit permission provided that full credit, including © notice, is given to the source. Mortgage Design in an Equilibrium Model of the Housing Market Adam M. Guren, Arvind Krishnamurthy, and Timothy J. McQuade NBER Working Paper No. 24446 March 2018, Revised December 2019 JEL No. E4,G0,G01,G2 ABSTRACT How can mortgages be redesigned to reduce housing market volatility, consumption volatility, and default? How does mortgage design interact with monetary policy? We answer these questions using a quantitative equilibrium life cycle model with aggregate shocks, long-term mortgages, and an equilibrium housing market, focusing on designs that index payments to monetary policy. Designs that raise mortgage payments in booms and lower them in recessions do better than designs with fixed mortgage payments. The benefits are quantitatively substantial: In a simulated crisis under a monetary regime in which the central bank lowers real interest rates in a bust, house prices fall 2.24 percentage points less, 23 percent fewer households default, and consumption falls by 0.79 percentage points less with ARMs relative to FRMs. Among designs that reduce payments in a bust, we show that those that front-load the payment reductions and concentrate them in recessions outperform designs that spread payment reductions over the life of the mortgage. Front-loading alleviates household liquidity constraints in states where they are most binding, reducing default and stimulating housing demand by new homeowners. To isolate this channel, we compare an FRM with a built-in option to be converted to an ARM with an FRM with an option to be refinanced at the prevailing FRM rate. Under these two contracts, the present value of a lender's loan falls by roughly an equal amount, but the FRM that can be converted to an ARM, which front loads payment reductions, reduces the declines in prices and consumption six times as much, and reduces default three times as much. Adam M. Guren Department of Economics Boston University 270 Bay State Road Boston, MA 02215 and NBER[guren@bu.edu](guren@bu.edu) Arvind Krishnamurthy Stanford Graduate School of Business Stanford University 655 Knight Way Stanford, CA 94305 and NBER[akris@stanford.edu](akris@stanford.edu) Timothy J. McQuade Stanford Graduate School of Business School 655 Knight Way Stanford, CA 94305 [tmcquade@stanford.edu](tmcquade@stan

FAQs

How does the paper propose redesigning mortgages to reduce volatility and default?

It evaluates mortgage designs that index payments to monetary policy in an equilibrium life-cycle model, aiming to reduce housing market and consumption volatility while lowering defaults.

Why do payment reductions that are larger in recessions outperform fixed payment mortgages?

The results show that designs raising payments in booms and lowering them in recessions perform better quantitatively, improving house prices, default rates, and consumption during simulated crises.

What is the advantage of front-loading payment reductions during downturns?

Front-loading concentrates reductions when household liquidity constraints bind most, which reduces default and increases housing demand from new homeowners more than designs that spread reductions over the mortgage life.

Sep 4, 2026

Uploaded by Patrick