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How Much Extra Premium Does a Loss-averse Owner-occupied Home Buyer Pay for His House?

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  • Mao-wei Hung
  • Leh-chyan So

Abstract

The dual role of houses as durable consumption goods and as financial investments makes the option approach a suitable method for evaluating them. When the buyer of an owner-occupied home spends a large amount of money on a house, he pays the bill to cover not only construction costs but also the premium for an at-the-money call on the house. With loss aversion, he believes that if the house price rises from its current price (i.e., the strike price), he may make a profit by selling the house. On other hand, if the house price drops, he just keeps the house to wait for a better selling price, and treats the house as a durable good that provides him with shelter. The dual role of houses enables the homebuyer to enjoy the upside potential from the viewpoint of investment, but to eliminate the downside risk from the viewpoint of consumption. As a result, we propose that homebuyers are often willing to pay more for a house as a call premium. In addition, both the homeownership constraint and the homebuyer’s ambiguity aversion will influence his subjective evaluation of the call. Copyright Springer Science+Business Media, LLC 2012

Suggested Citation

  • Mao-wei Hung & Leh-chyan So, 2012. "How Much Extra Premium Does a Loss-averse Owner-occupied Home Buyer Pay for His House?," The Journal of Real Estate Finance and Economics, Springer, vol. 45(3), pages 705-722, October.
    • Handle: RePEc:kap:jrefec:v:45:y:2012:i:3:p:705-722
    DOI: 10.1007/s11146-010-9293-9
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    References listed on IDEAS

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