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Risky mortgages in a DSGE model

Risky mortgages in a DSGE model
Risky mortgages in a DSGE model
This paper develops a DSGE model with housing, risky mortgages, and endogenous default. Housing investment is subject to idiosyncratic risk, and some mortgages are defaulted in equilibrium. An unanticipated increase in the standard deviation of housing investment risk produces a credit crunch where delinquencies and mortgage interest rates increase, lending is curtailed, and aggregate demand for non-durable goods falls. The economy experiences a recession as a consequence of the credit crunch. The paper compares economies that differ only in the riskiness of housing investment. Economies with lower risk are characterized by lower steady-state mortgage default rates and higher loan-to-value and leverage ratios. The macroeconomic effects of an unanticipated increase in housing investment risk are amplified in high-leverage economies. Monetary policy plays an important role in the transmission of housing investment risk, as inertial interest rate rules generate deeper output contractions.
1815-4654
285-335
Forlati, Chiara
7be0a723-e9b7-4247-8d6f-bfe224d61845
Lambertini, Luisa
67036ffb-7d8c-4be5-8f20-426f2238ecfc
Forlati, Chiara
7be0a723-e9b7-4247-8d6f-bfe224d61845
Lambertini, Luisa
67036ffb-7d8c-4be5-8f20-426f2238ecfc

Forlati, Chiara and Lambertini, Luisa (2011) Risky mortgages in a DSGE model. International Journal of Central Banking, 7 (1), 285-335.

Record type: Article

Abstract

This paper develops a DSGE model with housing, risky mortgages, and endogenous default. Housing investment is subject to idiosyncratic risk, and some mortgages are defaulted in equilibrium. An unanticipated increase in the standard deviation of housing investment risk produces a credit crunch where delinquencies and mortgage interest rates increase, lending is curtailed, and aggregate demand for non-durable goods falls. The economy experiences a recession as a consequence of the credit crunch. The paper compares economies that differ only in the riskiness of housing investment. Economies with lower risk are characterized by lower steady-state mortgage default rates and higher loan-to-value and leverage ratios. The macroeconomic effects of an unanticipated increase in housing investment risk are amplified in high-leverage economies. Monetary policy plays an important role in the transmission of housing investment risk, as inertial interest rate rules generate deeper output contractions.

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Published date: March 2011
Organisations: Economics

Identifiers

Local EPrints ID: 382367
URI: http://eprints.soton.ac.uk/id/eprint/382367
ISSN: 1815-4654
PURE UUID: 4c670d64-c037-4ff2-b789-8a5e8622677f
ORCID for Chiara Forlati: ORCID iD orcid.org/0000-0003-2914-1504

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Date deposited: 14 Oct 2015 14:00
Last modified: 15 Mar 2024 03:50

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Contributors

Author: Chiara Forlati ORCID iD
Author: Luisa Lambertini

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