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Hedging Housing Risk in London

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Author Info

  • Matteo Iacoviello

    () (Boston College)

  • Francois Ortalo-Magne

    () (London School of Economics)

Abstract

This paper investigates the benefits of allowing households to compensate the portfolio distortion due to their housing consumption through investments in housing price derivatives. Focusing on the London market, we show that a major loss from over-investment in housing is that households are forced to hold a very risky portfolio. However, the strong performance of the London housing market means that little is lost in terms of expected returns. Even households with limited wealth are better off owning their home rather than renting and investing in financial assets, as long as they are willing to face the financial risk involved. In this context, access to housing price derivatives would benefit most poor homeowners looking to limit their risk exposure. It would also benefit wealthier investors looking for the high returns provided by housing investments without the costs of direct ownership of properties. Comparisons with French, Swedish and US data provide a broader perspective on our findings.

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Bibliographic Info

Paper provided by Boston College Department of Economics in its series Boston College Working Papers in Economics with number 539.

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Length: 23 pages
Date of creation: 03 Oct 2002
Date of revision:
Publication status: Forthcoming in Journal of Real Estate Finance and Economics
Handle: RePEc:boc:bocoec:539

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Keywords: portfolio risk; house price index; hedging;

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References

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  1. John Y. Campbell & Luis M. Viceira, 1996. "Consumption and Portfolio Decisions When Expected Returns are Time Varying," NBER Working Papers 5857, National Bureau of Economic Research, Inc.
  2. Joao Cocco, 2000. "Hedging House Price Risk With Incomplete Markets," Computing in Economics and Finance 2000 317, Society for Computational Economics.
  3. Karl E. Case & Robert J. Shiller & Allan N. Weiss, 1991. "Index-Based Futures and Options Markets in Real Estate," Cowles Foundation Discussion Papers 1006, Cowles Foundation for Research in Economics, Yale University.
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Citations

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Cited by:
  1. Sock Yong Phang, 2009. "Affordable homeownership policy: implications for housing markets," Working Papers 14-2009, Singapore Management University, School of Economics, revised Nov 2009.
  2. Buckley, Robert & Karaguishiyeva, Gulmira & Van Order, Robert & Vecvagare, Laura, 2003. "Comparing mortgage credit risk policies : an options-based approach," Policy Research Working Paper Series 3047, The World Bank.
  3. Ricardo M. Sousa, 2009. "Wealth Effetcs on Consumption: Evidence from the euro area," NIPE Working Papers 12/2009, NIPE - Universidade do Minho.
  4. Haavio, Markus & Kauppi, Heikki, 2009. "House price fluctuations and residential sorting," Research Discussion Papers 14/2009, Bank of Finland.
  5. Ortalo-Magne, Francois & Rady, Sven, 2002. "Tenure choice and the riskiness of non-housing consumption," Journal of Housing Economics, Elsevier, vol. 11(3), pages 266-279, September.
  6. Quigley, John M., 2006. "Real estate portfolio allocation: The European consumers' perspective," Journal of Housing Economics, Elsevier, vol. 15(3), pages 169-188, September.
  7. Charles Ka Yui Leung, 2005. "Equilibrium Correlation of Asset Price and Return," Discussion Papers 00017, Chinese University of Hong Kong, Department of Economics.
  8. Yongheng Deng & John Quigley, 2008. "Index Revision, House Price Risk, and the Market for House Price Derivatives," The Journal of Real Estate Finance and Economics, Springer, vol. 37(3), pages 191-209, October.
  9. Jan Rouwendal, 2009. "Housing Wealth and Household Portfolios in an Ageing Society," De Economist, Springer, vol. 157(1), pages 1-48, March.
  10. Ricardo M. Sousa, 2007. "Wealth Shocks and Risk Aversion," NIPE Working Papers 28/2007, NIPE - Universidade do Minho.
  11. Juerg Syz & Paolo Vanini & Marco Salvi, 2008. "Property Derivatives and Index-Linked Mortgages," The Journal of Real Estate Finance and Economics, Springer, vol. 36(1), pages 23-35, January.

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