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