Monday, November 2, 2009

Houses are a poor way to share risk

Owning a house is a terribly risky investment, not only because of the volatility of its value, but also because of the high correlation between house value and local economic conditions which also determine labor income. In other worth, owning a house you live in is among the worst things one can do in terms of diversification. Two recent papers revisit some aspects of this.

Dmytro Hryshko, María José Luengo-Prado and Bent Sørensen show that houses still provide substantial consumption smoothing ability to households suffering from a job loss. Obviously, when there is job loss and house equity loss, things look bad, but home owners still do better than renters. What this means is that the fact of holding some equity is more important that the lack of diversification. But it remains that better diversified households would still do better.

Todd Sinai and Nicholas Souleles argue that the risk is not that bad once you consider that when you sell a house you need to buy another one. So if you have to sell low, you are likely to buy low as well. This works obviously if you move locally, but appears also to work quite well for moves to another metropolitan area, as house prices across such areas in the US have an expected correlation between 0.35 and 0.60. So things are not as bad as one would have thought.

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