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Why Are There No Fixed-Rate Mortgages in Taiwan. Yao-Min Chiang Department of Finance National Chengchi University August 28, 1998. Mortgage Instruments. Fixed-rate mortgages (FRMs) Adjustable-rate mortgages (ARMs) FRMs ARMs --------------------------------------------------
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Why Are There No Fixed-Rate Mortgages in Taiwan Yao-Min Chiang Department of Finance National Chengchi University August 28, 1998
Mortgage Instruments • Fixed-rate mortgages (FRMs) • Adjustable-rate mortgages (ARMs) FRMs ARMs -------------------------------------------------- Borrowers bear Borrowers bear no interest rate risk all interest rate risk
Borrowers Mortgage Choice Strategy • The objective of a borrower is to maximize hie/her utility.
Pooling Equilibrium - All borrowers choose ARMs • the condition for G4 to be the equilibrium outcome is: • Given r0<E(r1), we have • Given r0>E(r1), we have
Pooling Equilibrium - All borrowers choose ARMs • A quadratic utility function is used to run the numerical analysis. • Market Equilibrium
Borrowers' choice behavior change due to a change in borrowers' initial income
Borrowers' choice behavior change due to a change in borrowers' expectation about future income
Borrowers' choice behavior change due to a change in the interest rate volatility
Borrowers' choice behavior change due to a change in the initial interest rate
Borrowers' choice behavior change due to a change in the expectation about future interest rates
Borrowers' choice behavior change due to change in the ratio of expected future interest rate over expected future income
Conclusion • The tilt of income stream, plays a key role on borrower choice behavior. • The slope of the yield curve, is the key factor affecting mortgage choice. • Income and interest rates have an interaction on mortgage choice. • Downward sloping of the term structure of interest rates, low interest rate volatility, combined with the expectation of higher future payment-to-income ratio are the reason causing there are only ARMs in Taiwan's mortgage market.
Pooling Equilibrium - All borrowers choose ARMs • the condition for G4 to be the equilibrium outcome is: • Given r0<E(r1), we have • Given r0>E(r1), we have