JOB MARKET PAPER

The Choice to Rent or Own: Why Rents and Mortgages Rates Are Jointly Determined

This paper proposes a unified framework of housing choice in the presence of a lenders’ and landlords’ market. I consider a finitely lived risk averse agent who is exposed to two sources of uncertainty: stochastic labor income and stochastic house price. The main contribution is to jointly derive the default risk premium, determined by expected losses due to default on the mortgage, and the rent risk premium, determined by the risk of house prices fluctuations. The agent, as an owner, optimally determines the time at which defaulting and moving into the rental market provides a greater expected continuation utility than continuing the mortgage payments. Consequently, the default and rent risk premia are systematically related. The model predicts that the default and rent risk premia are both increasing in the volatility of labor income and house prices. In addition, the default risk premium (the rent risk premium) is increasing (decreasing) with respect to the correlation between them.

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PRESENTATIONS AND TECHNICAL REPORTS

• "Housing Consumption in the Presence of Mortgage and Bankruptcy Risk". Presented at the London Business School Trans-Atlantic Doctoral Conference, May 2007.

• “Valuing the Surrender Options Embedded in a Portfolio of Italian Life Guaranteed Participating Policies: a Least Squares Monte Carlo Approach”, with Giulia Andreatta. Presented at the 7th Annual International Congress on Insurance, Mathematics and Economics, 2003, Lyon, France; the AFIR Colloquium, 2003, Maastricht, Netherlands; the 8th Annual International Conference on Real Options, 2004, Montreal, Canada.

• “Economic Risk Capital and Reinsurance: an Extreme Value Theory’s Application to Fire Claims of an Insurance Company”. Presented at the 6th Annual International Congress on Insurance, Mathematics and Economics, 2002, Lisbon, Portugal; the Astin 2003, Berlin, Germany.