Expected Return of Housing and Mortgage Termination

Abstract

The prepayment risk of adjustable rate mortgages, unlike that of fixed rate mortgages, greatly depends on the decision of mortgagors to move. Given that housing also serves as an investment asset for the owner, it is hypothesised that the expected capital returns of housing are likely to affect his decision to move and hence, prepay. This paper aims to test the capital gains hypothesis using Singapore?s housing market as a case study. In addition, this paper also explores how the expected returns from alternative types of housing affect the decision of households to move/prepay. The expected returns of housing are computed in accordance with the definitions
of the Rational Expectation Hypothesis, Adaptive Expectation Hypothesis, and Exogenous Expectation Hypothesis, which are well established in macroeconomic literature and the explanation of cycles. The results showed that the expected returns of public housing formed under the assumptions of rational and adaptive expectation hypothesis are significant. The rational
expected return for private housing, however, does not have a significant relationship with the decision of mortgagors to move/prepay, although the adapted expected return for private housing is not significantly related to the households? length of stay.
 

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