A Theory of Housing Collateral, Consumption Insurance and Risk Premia

Abstract

In a model with housing collateral, a decrease in house prices reduces the collateral value of housing, increases household exposure to idiosyncratic risk, and increases the conditional market price of risk. This collateral mechanism can quantitatively replicate the conditional and the cross-sectional variation in risk premia on stocks for reasonable parameter values. The increase of the conditional equity premium and Sharpe ratio when collateral is scarce in the model matches the increase observed in US data. The model also generates a return spread of value firms over growth firms of the magnitude observed in the data, because the term structure of consumption strip risk premia is downward sloping.

Housing Collateral, Consumption Insurance, and Risk Premia: An Empirical Perspective

“…The housing collateral mechanism endogenously generates heteroskedasticity and counter-cyclicality in the market price of risk. In Lustig and Van Nieuwerburgh (2004a), we solve for the equilibrium of the model numerically, while this paper focuses on connecting the model to the data. We specify the liquidity factor in the SDF as a semiparametric function of the housing collateral ratio and the aggregate pricing factors.…”

“…In Lustig and Van Nieuwerburgh (2004a), we fully calibrate and solve the model. The equilibrium aggregate liquidity shock is a function of the primitives of the model: the preferences, the household endowment process, the aggregate endowment process, and the aggregate nondurable expenditure ratio process.…”

“…The graph shows a 200-period simulation of the model at an annual frequency. The parameters are δ = 0.95, γ = 8, and ε = 0.15.The calibration is discussed in detail inLustig and Van Nieuwerburgh (2004a).…”

Corporate Real Estate Holdings and the Cross-Section of Stock Returns

“…Even though real estate is an important component of aggregate wealth, it is generally omitted from the empirical and theoretical work in the asset pricing literature. A few notable exceptions include Stambaugh (1982); Kullman (2003); Flavin and Yamashita (2002); Piazzesi, Schneider, and Tuzel (2007); and Lustig and Nieuwerburgh (2006). Stambaugh (1982) constructs market portfolio as a combination of several asset groups, some of which includes proxies for residential real estate in his tests of CAPM.…”

Booms and Busts: Consumption, House Prices and Expectations

“…Lustig and van Nieuwerburgh (2005) consider a model where housing is used as a collateral in risk‐sharing agreements so that an increase in house prices increases the ability that individuals have to smooth out shocks.…”