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Interest Rate Risk, Residential Mortgages and Financial Futures Markets
Author(s) -
Gau George W.,
Goldberg Michael A.
Publication year - 1983
Publication title -
real estate economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.064
H-Index - 61
eISSN - 1540-6229
pISSN - 1080-8620
DOI - 10.1111/1540-6229.00300
Subject(s) - futures contract , interest rate , rollover (web design) , economics , forward market , interest rate risk , volatility (finance) , financial economics , financial market , monetary economics , finance , world wide web , computer science
Residential mortgage markets in both the United States and Canada have recently been dominated by instruments such as variable‐rate and short‐term rollover mortgages which require borrowers to assume a greater burden of interest rate risk. An outstanding question is whether this approach to risk allocation is Pareto optimal or whether there are other more effective methods of dealing with the risk created by interest rate volatility. This study examines the potential for shifting this risk from the mortgage market to the financial futures market. After considering the rationale for expecting that neither mortgage borrowers nor lenders wish to absorb the high levels of risk present in the existing financial environment, this study discusses the hedging of interest rate risk through financial futures markets. Empirical tests are then performed to evaluate the effectiveness of U.S. futures markets for hedging positions from the U.S. mortgage market. These results indicate that the interest rate risk inherent in residential mortgages can be substantially shifted through one or more positions in the existing futures contracts and long‐term, fixed‐rate mortgages may still be financially feasible under conditions of interest rate volatility.