Hedging Real Estate Risk

Abstract (Via SSRN)

Real-estate assets represent more than one-third of the value of all the underlying physical capital in the United States and the world. The relationship between the level of interest rates and housing prices does not always follow one direction and a shock event in one market may trigger deep repercussions in the other. With the spread of the securitization process, the risks rooted in these two fundamental markets can have far reaching outcomes.

Introduction (Via Shiller, Fabozzi, & Tunaru)

Prices in the residential housing market are determined by direct trade between buyers and sellers who are influenced by emotional involvement and other opaque social factors such as change of employment or change of school for children. Residential real-estate assets are naturally not diversified and are a combination of a consumption asset and a leveraged investment. As Shiller and Weiss [1999] point out, this characteristic poses greater risk for the financial stability of individuals due to geographic fluctuations in property prices.

Additional Excerpts (Via Shiller, Fabozzi, & Tunaru)

Ideally, homeowners could use derivatives on relevant real-estate indices to hedge this risk and stabilize prices.

While it would be difficult for homeowners to hedge directly the price of their homes, banks and building societies that have mortgage portfolios more diversified nationally should be enticed to hedge their exposure with derivatives written on local indices.

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17. June 2009 by Miguel Barbosa
Categories: Curated Readings, Finance & Investing | Leave a comment

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