Risky Mortgages in a DSGE Model

International Journal of Central Banking, March 2011

Posted: 12 Mar 2011 Last revised: 17 Mar 2011

See all articles by Luisa Lambertini

Luisa Lambertini

École Polytechnique Fédérale de Lausanne

Chiara Forlati

University of Southampton - Department of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: March 10, 2011

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.

Keywords: Housing, Mortgage Default, Mortgage Risk

JEL Classification: E32, E44, G01, R31

Suggested Citation

Lambertini, Luisa and Forlati, Chiara, Risky Mortgages in a DSGE Model (March 10, 2011). International Journal of Central Banking, March 2011 , Available at SSRN: https://ssrn.com/abstract=1782665

Luisa Lambertini (Contact Author)

École Polytechnique Fédérale de Lausanne ( email )

Odyssea
Station 5
Lausanne, 1015
Switzerland

Chiara Forlati

University of Southampton - Department of Economics ( email )

University of Southampton
Murray Building, Salisbury Rd
Southampton UK, SO17 1BJ
United Kingdom

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