82nd International Atlantic Economic Conference

October 13 - 16, 2016 | Washington, USA

Mortgages and risk preference: Evidence from the Consumer Expenditure Survey

Friday, October 14, 2016: 9:20 AM
Taylor Wilson, Economist , Division of Consumer Expenditure Surveys, U.S. Bureau of Labor Statistics, Consumer Expenditure Survey Program, Washington, DC
Understanding risk preference is instrumental in explaining consumer behavior. The goal of this study is to relate mortgage choice with a specific type of risk preference using consumer choice theory and expectations as a theoretical framework for examining the data.

Each mortgage instrument carries with it an inherent interest rate risk for both the lender and the borrower. Given the inherent risk associated with these instruments, this study seeks to understand how risk averse individuals approach mortgage selection. The Consumer Expenditure Interview Survey captures information regarding consumer expenditures and mortgage choice from 2004-2014.

This paper uses the decision to purchase health insurance as a proxy for risk averse behavior and the amount of a health insurance expenditure to capture relative risk aversion between consumer units. Those households that are risk averse are more likely to purchase a less risky type of instrument. Additionally, if they are risk averse, we observe a positive correlation between fixed rate mortgage purchases and the amount spent on health insurance.

The period of study allows for an examination of behavior surrounding the 2007 housing market collapse. Expectation theory suggests that a large shock to the market would alter expectations for consumers. Operating under the guiding assumption that most consumers are risk averse, we expect to see the housing market reorganize into a less risky state following the collapse because payoff expectation in the mortgage market was damaged.

In the years prior to the economic collapse it was much more likely that a consumer would have selected a risky mortgage instrument. Following the collapse of the housing market, consumers purchased less risky instruments as the market recovered. The data show a precipitous decline in the number of adjustable rate mortgages in the sample following the collapse of the market in both percentage and absolute terms.