Mortgage Contracts and the Definitions of and Demand for Housing Wealth
Nichols, Joseph B
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Owner-occupied housing plays a central role in the portfolios of many households. Recent work has explored the connection between a household's position in home equity and the demand for risky assets in the financial portfolio. This dissertation examines the role of the mortgage contract on the definition of and demand for housing wealth. This first chapter develops a detailed partial equilibrium model of housing wealth's role over the life-cycle to explore (1) housing's dual role as a consumption and investment good; (2) the significance of the mortgage contract being in nominal and not real terms; and (3) the tax benefits associated with owner-occupied housing. The household's dynamic stochastic programming problem is solved using parallel processing. The results show that the ``over-investment'' in housing is not just a function of consumption demand but also can be driven by the benefits inherent in the mortgage contract. It also shows that the nominal mortgage contract results in the non-neutrality of perfectly expected inflation. Finally, the paper documents the effect of preferential tax treatment on housing demand. This paper develops an alternative measure of the return on housing that incorporates the consumption stream and the required mortgage payments associated with owner-occupied housing. This measure is then used to demonstrate how the total return on housing varies with anticipated holding length, terms of the mortgage contract, and borrower income level. Data from the Panel Study of Income Dynamics and the Survey of Consumer Fiance are used to explore the empirical relationship between property, mortgage, and borrower characteristics and the total return on housing, the probability of negative total return, and the demand for risky assets.