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The Diversification Benefits of Free Trade in House Value

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  • M.I. Dröes
  • H. Garretsen
  • W.J.J. Manshanden
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    Abstract

    This paper finds that homeowners could substantially reduce house price risk if they would reinvest their housing wealth in a market portfolio of houses. Free trade in the value of the house among homeowners would allow them to do so. To quantify the diversification benefits of free trade in house value, we estimate simple CAPM and APT models based on a detailed panel dataset of house price changes in the Netherlands. We find that about 92 to 96 percent of house price risk is diversifiable. In most cases, these diversification benefits outweigh the hedging effectiveness of house price futures.

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    File URL: http://dspace.library.uu.nl/bitstream/handle/1874/269223/12-03.pdf
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    Bibliographic Info

    Paper provided by Utrecht School of Economics in its series Working Papers with number 12-03.

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    Length: 15 pages
    Date of creation: Feb 2012
    Date of revision:
    Handle: RePEc:use:tkiwps:1203

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    Related research

    Keywords: house price risk; free trade; financial market; diversification; futures;

    This paper has been announced in the following NEP Reports:

    References

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    1. Karl Case & John Cotter & Stuart Gabriel, 2010. "Housing Risk and Return: Evidence From a Housing Asset-Pricing Model," Working Papers 201005, Geary Institute, University College Dublin.
    2. Christopher L. Foote & Kristopher Gerardi & Paul S. Willen, 2008. "Negative equity and foreclosure: theory and evidence," Public Policy Discussion Paper 08-3, Federal Reserve Bank of Boston.
    3. Todd M. Sinai & Nicholas S. Souleles, 2009. "Can Owning a Home Hedge the Risk of Moving?," NBER Working Papers 15462, National Bureau of Economic Research, Inc.
    4. Christoph Hinkelmann & Steve Swidler, 2008. "Trading House Price Risk with Existing Futures Contracts," The Journal of Real Estate Finance and Economics, Springer, vol. 36(1), pages 37-52, January.
    5. Shiller, Robert J., 2008. "Derivatives Markets for Home Prices," Working Papers 46, Yale University, Department of Economics.
    6. Andrew Caplin & William Goetzmann & Eric Hangen & Barry Nalebuff & Elisabeth Prentice & John Rodkin & Matthew Spiegel & Tom Skinner, 2003. "Home Equity Insurance: A Pilot Project," Yale School of Management Working Papers ysm372, Yale School of Management, revised 23 Jan 2006.
    7. Han, Lu, 2008. "Hedging house price risk in the presence of lumpy transaction costs," Journal of Urban Economics, Elsevier, vol. 64(2), pages 270-287, September.
    8. Peter ENGLUND & Min HWANG & John M. QUIGLEY, 2000. "Hedging Housing Risk," FAME Research Paper Series rp26, International Center for Financial Asset Management and Engineering.
    9. Todd Sinai & Nicholas S. Souleles, 2005. "Owner-Occupied Housing as a Hedge Against Rent Risk," The Quarterly Journal of Economics, MIT Press, vol. 120(2), pages 763-789, May.
    10. 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.
    11. Quigley, John M., 2006. "Real Estate Portfolio Allocation: The European Consumers’ Perspective," Berkeley Program on Housing and Urban Policy, Working Paper Series qt14v7g9f8, Berkeley Program on Housing and Urban Policy.
    12. Mark Bertus & Harris Hollans & Steve Swidler, 2008. "Hedging House Price Risk with CME Futures Contracts: The Case of Las Vegas Residential Real Estate," The Journal of Real Estate Finance and Economics, Springer, vol. 37(3), pages 265-279, October.
    13. Marjorie Flavin & Shinobu Nakagawa, 2008. "A Model of Housing in the Presence of Adjustment Costs: A Structural Interpretation of Habit Persistence," American Economic Review, American Economic Association, vol. 98(1), pages 474-95, March.
    14. 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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