Adjustable and fixed interest rates mortgage markets modelling

Abstract

Due to recent developments in credit markets, the interdependencies among fixed rate mortgages (FRMs) and adjustable rate mortgages (ARMs) markets are analysed in the study of the interactions within credit markets since it appears very suitable and interesting. A meaningful and complete database of information on Financial Institutions (FIs) in Italy (1997Italy ( :q1 -2011) hold by the Banca d'Italia shows that the relative importance of these markets recently displayed significant fluctuations since in 2005 fixed interest rate mortgage loans were about 10% while in 2009 they raised up to 70%. In the context of the FRMs and ARMs characteristics in Italian markets as well as the available database, among the proposed models for the study of interconnected markets (see Hommes (1997, 1998), Westerhoff (2009, 2010) and related literature citetd therein), the models recently developed by Casellina et al. ( 2011) is applied to test its capacity to capture the dynamics of the observed data. It is worth stressing that the involved real data (volume of contracts and average interest rate in the FRMs and ARMs markets) are not sample information but they are evaluated on the entire population. The obtained findings point out the good level to fit the interest rates dynamics. Moreover, the model captures the switching mechanism and it catches the structural breaks when they occurs.

Italian mortgage markets and their dynamics

“…Therefore, updating the data reported in Casellina et al (2011) and Uberti et al (2013) to the third quarter of 2012 (Figure 1), it turns out that the spread Δρ t = ρ X,t − ρ Z,t between the average fixed rate ρ X,t and the adjustable one ρ Z,t was inversely related to interest rate EURIBOR ι t : this correlation was −0.7882. It also emerges that, over time, a mechanism of switching was put in action among customer preferences between FRMs and ARMs.…”

“…In Casellina et al (2011) and Uberti et al (2013) some of the dynamics of the Italian markets of FRMs and ARMs are analysed: the switching mechanism between these two markets is pointed out by historical data on the universe of mortgages in Italy since 1999 (the year of entry into force of EURIBOR rates) to 2011 and an original model is proposed to grasp these peculiar interconnection behaviours. One of the fundamental assumptions of these studies is that the interest rates for mortgages are also indexed to the EURIBOR rate, among other factors.…”

“…The time series of Italian mortgage markets (see Figure 1; source Bank of Italy) used by Casellina et al (2011) and Uberti et al (2013) have become attractive not only, as stressed above, to look back at some phases of the recent past, but also for further aspects: (i) the interconnection between the two markets has become more evident by evaluating the series of the k-th market values V k,t = ρ k,t N k,t , where the average rate ρ k,t of the k-th type of market is defined as a price and the absolute number of contracts N k,t evaluates the demanded and, at the same time, the supplied quantities for the k-th type of contract, (ii) the volatility of market values and, finally, (iii) the effect that could induce a shock to the reference rate for mortgages, the EURIBOR rate ι t .…”

“…In order to study the dynamics of market shares, according to cobweb phenomenology, a mathematical model is developed in Casellina et al (2011) and applied because it turned out able to easily see the switching mechanisms observed between FRMs and ARMs markets. Then, from this initial mathematical model, an econometric model is derived and estimated in Uberti et al (2013). Although this derived econometric model reveals a good capacity to replicate the time series, it also highlights several questions that remained unanswered, including the effects of monetary policy on mortgage markets.…”

The state of financial modelling in 2012, as shaped by the GFC

“…Using a decision three methodology they are able to show how these forecasts outperform the random walk model. Uberti et al (2013) analyse the interactions among fixed rate and adjustable rate mortgages in the context of credit markets. They study the entire set of Italian mortgages over the period 1997-2011 and analyse their changing dynamics.…”