Two-Dimensional Self-Selection of Borrowers

Abstract

The multi-dimensional heterogeneity of agents can provide interesting insights. To illustrate this point in the loan market context, we examine the borrowers' decision to switch from a variable rate loan to a fixed rate loan, using a model of two-dimensional borrower types (risk aversion and riskiness). Among high risk borrowers, more risk averse ones are selected out of the loan market and less risk averse ones are not tempted by the fixed rate loan. Switchers are more risk averse but have lower default risk. The Financial Services Commission's 2015 Mortgage Refinancing Program in Korea is discussed under our model's framework.