Nominal Mortgage Contracts and the Effects of Inflation on Portfolio Allocation

50 Pages Posted: 17 Jul 2008

See all articles by Joseph Nichols

Joseph Nichols

Board of Governors of the Federal Reserve System

Date Written: December 1, 2007

Abstract

Households who wish to extract home equity through refinancing their mortgage face a hidden transaction cost. The real value of the fixed nominal mortgage payment declines over time with inflation. The change in the real value of the mortgage payments from taking on a new mortgage is positive and an increasing function of inflation; higher inflation thus discourages households from re-balancing their portfolio as frequently as they would otherwise. The life cycle model developed in this paper demonstrates how the share of total wealth held in housing is sensitive to the rate of inflation, even when perfectly anticipated. Households hold larger positions in home equity earlier in the life cycle and smaller positions later in the life cycle as the rate of inflation increases

Keywords: Mortgages, inflation, portfolio allocation, life-cycle

JEL Classification: E21, G11, G21, R21, C61

Suggested Citation

Nichols, Joseph, Nominal Mortgage Contracts and the Effects of Inflation on Portfolio Allocation (December 1, 2007). FEDS Working Paper No. 2007-67, Available at SSRN: https://ssrn.com/abstract=1161213 or http://dx.doi.org/10.2139/ssrn.1161213

Joseph Nichols (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States
202-452-2983 (Phone)

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