The optimal LTV-ratio, mortgage market variability and monetary policy regimes: A demand-side perspective

Abstract

Purpose

The purpose of this paper is twofold: first, it derives the optimal loan-to-value (LTV)-ratio for a mortgagor that maximizes the return to home equity when considering the capital structure of housing investment. Second, it analyses the demand-side contribution to mortgage market variability across monetary policy regimes.

Design/methodology/approach

The paper endogenizes both the relation between the LTV ratio and the mortgage rate and the relation between LTV and the rate of appreciation. When we consider LTV-variance and the demand-side contribution to mortgage market variability, three stylized regimes is considered.

Findings

The paper finds an intuitive ranking of the optimal LTV-ratios across regimes, and the optimal LTV-ratio peaks during a housing boom. When, however, monetary policy ignores asset inflation the demand-side contribution to market variability is highest during normal market conditions. Hence, there is a potentially hump-shaped relation between the risk exposure of individual mortgagors and the demand-side contribution to mortgage market variability.

Originality/value

The paper finds a potentially hump-shaped relation between the risk exposure of individual mortgagors and the demand-side contribution to mortgage market variability, which, to the best of our knowledge, is novel. The paper shows how macro-prudential and monetary policy are complementary tolls for preserving financial stability.

Citation

Borgersen, T.A. (2017), "The optimal LTV-ratio, mortgage market variability and monetary policy regimes: A demand-side perspective", Journal of Financial Economic Policy, Vol. 9 No. 02, pp. 225-239. https://doi.org/10.1108/JFEP-06-2016-0044