The Transmission of an Interest Rate Shock, Standard Mitigants and Household Behavior

We analyze the transmission of an interest rate shock to households in the context of a stress-test module. We examin standard mitigants, such as delays due to a future interest-rate-reset-date, tax deduction of the interest paid on mortgages, the amortization of different mortgage types and conjunctural factors. We also include the possibility of behavioral responses, where households can alleviate the effect of a shock by reducing debt using voluntary repayments. We estimate a Cragg log-normal hurdle model on loan-level data for the Dutch mortgage market. We simulate debt 30 years into the future under different scenarios for the development of the interest rate and simulating both contractual and voluntary amortization. This study finds a significant dampening role of voluntary repayments on the effects of an interest rate shock.
 
Keywords: transmission of interest rate shock; voluntary repayments, loan level data.
JEL classifications: C01; C23; D14; E44; G21.

Working paper no. 615