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The Cox-Ingersoll-Ross and Chen-Scott models of term structure are examined in an effort to explain how yields on short-term and long-term bonds relate. The 'predictability smile' in which spreads between the long- and short-term interests rates seem to forecast changes for the short rates is also examined.

Housing activity grew between 1982 and 1984, as did the use of adjustable rate mortgages (ARMs). Doubt is expressed, however, about trade literature assertions that the ARMs stimulated housing activity. A statistical housing forecasting model is used to show empirically that ARMs did not in fact increase housing consumption very much. The evidence indicates instead that declining fixed mortgage interest rates between 1982 and 1983 promoted much of the housing activity growth. ARM demand can still be rationalized by borrowers' desire to 'smooth' consumption in light of uncertain future incomes, even in circumstances when use of ARMs results in no extra borrower consumption of housing.