Hedging house price risk with incomplete markets

Subject

Finance

Publishing details

Social Sciences Research Network

Authors / Editors

Cocco J

Biographies

Publication Year

2003

Abstract

This paper solves a model of the optimal asset and consumption choices of a liquidity constrained investor who derives utility from the consumption of both non-durable consumption goods and housing. Using PSID labor income and house price data I estimate a large positive correlation between income shocks and house price shocks, and a large negative correlation between house prices and interest rates. I use these estimates to parameterize the model. Using the model I evaluate the effects of labor income, interest rate and house price risk on housing choices and investor welfare. Due to the dual role of housing as an asset and a source of consumption services, liquidity constraints are an important determinant of hedging demands.

Keywords

Hedging demands, asset choices, interest rate risk, house price risk, labor income risk, borrowing constraints

Series

Social Sciences Research Network