Mortgage Choice and Inflation Experiences in the Eurozone

ABSTRACT

In the Eurozone, households' mortgage preferences vary widely, both within and across countries. This persistent heterogeneity in the choice between an adjustable rate mortgage (ARM) and a fixed rate mortgage (FRM) two decades after introducing a common currency is a puzzle. We argue that these patterns relate to the long-lasting effect of personal experiences of high-inflation periods. Analysing rich household data across 9 countries, we show that higher lifetime experienced inflation predicts significantly lower probability of holding an FRM: a 1 log-point increase in experienced inflation predicts a 71% decrease in the odds of holding an FRM. We relate our findings to existing theories on household mortgage risk management and argue that Eurozone prepayment penalties heighten the `inflation risk' associated with FRMs. We also find that past personal inflation experiences are associated to risk aversion: households with histories of high and volatile inflation report lower willingness to take financial risk.

Keywords:

Experience effects, Household surveys, Inflation, Mortgage choice

Presented at:

Banque de France-CEPR-ECB Conference on Monetary Policy Challenges for European Macroeconomies (Paris), LACEA LAMES Annual Meeting (Lima), HEC Paris Finance PhD Workshop (Paris), XXXVII Jornadas Anuales de Economía Banco Central del Uruguay (Montevideo), 4th Behavioral Macroeconomics Workshop (Bamberg), Spring Meeting of Young Economists (Orleans), CREi Macro Lunch, CREi International Lunch