Grants

The Independent Research Fund Denmark (DFF) International Postdoc Grant - Principal Investigator - 1.4 million DKK

Press Coverage: https://dff.dk/cases/hvordan-vaelger-bank-og-kunde-hinanden-nar-der-skal-lanes-til-et-hus

Buying a home is the most important financial decision that most people will make in their life. The primary sources of finance for households when buying a home are banks and mortgage credit institutions (MCIs). The types of mortgage products offered by these institutions deeply affect individuals’ lifetime well-being. This project investigates how the structure of, and changes in, the mortgage market affect both individual and overall social welfare.

While it is a matter of course that households ultimately choose their institutions and mortgage products, it is also important to recognize that the institutions themselves have incentives to choose customers with specific characteristics. These incentives are sometimes influenced by regulatory concerns. For example, the Danish FSA introduced in 2016 restrictions on the number of loans a bank can serve to customers for which the Loan to Income (LTI) ratio exceeds a factor of 4 in the Copenhagen metropolitan area and Aarhus. This is an example of a macroprudential policy which has become a focus point for policy makers since the financial crisis in 2007. To assess the welfare impact of new and potential developments in the mortgage market, it is important to consider both sides of the market and how they interact. In this project, we

1) determine what drives the terms of trade, i.e. pricing and other details of a mortgage contract, and the assignments between any particular individual and institution, and

2) determine how individuals and institutions will behave in response to structural and regulatory changes in the mortgage market.

We do this by extending state-of-the-art theoretical and empirical methodologies and applying it to unique data covering the population of Danish individuals and the universe of credit institutions and mortgage transactions.

This project will help to improve the quality of the Danish mortgage market by identifying direct and indirect trade-offs associated with policy proposals aimed at managing systemic risks. For example, policy makers would be interested in a counterfactual policy experiment that removes a particular institution (e.g. Bank A goes bankrupt) or a type of mortgage product (e.g. interest-only loans), to determine how the portfolio of loans for the remaining institutions will be impacted, and which customer types will experience the greatest losses/gains in the mortgage market.

Theoretical foundation: We will analyse this pattern of banking relationships and the allocation of gains within these relationships using a two-sided revealed preference framework. Our framework assumes individuals and institutions can compensate each other using transfer payments, which the literature refers to as transferable utility (TU). Moreover, participants on both sides of the market operate competitively and can freely choose trading partners subject to finding agreeable terms of trade. Our theoretical foundation is the “two-side stable matching model with TU” framework which is well known in the market design literature, pioneered by the Nobel Prize winners Alvin Roth and Lloyd Shapley, also known as the Becker model referring to Becker (1973). To estimate this Becker model, we will extend recent developments in econometric methods presented in Fox 2007, 2010, 2018, Akkus et al., 2016, and Fox, Yang & Hsu, 2018.