Optimal Portfolio Choices, House Risk Hedging and the Pricing of Forward House Transactions

39 Pages Posted: 14 Oct 2009 Last revised: 16 Nov 2010

See all articles by Gang-Zhi Fan

Gang-Zhi Fan

Beijing Normal University-Hong Kong Baptist University United International College

Ming Pu

Southwestern University of Finance and Economics (SWUFE) - Research Institute of Economics & Management

Seow Eng Ong

affiliation not provided to SSRN

Multiple version iconThere are 2 versions of this paper

Date Written: October 8, 2009

Abstract

This paper develops a utility indifference model for evaluating various prices associated with forward transactions in the housing market, based on the equivalent principle of expected wealth utility derived from the forward and spot real estate markets. Our model results show that forward transactions in the housing market are probably not due to house sellers’ and buyers’ heterogeneity, but to their demand for hedging against house price risk. When the imperfections of real estate markets and the risk preferences of market participants are taken into consideration, we are able to show that the idiosyncratic risk premium, which mainly depends on the participants’ risk preferences and the correlation between the traded asset and the real estate, is a remarkable determinant of house sellers’ and buyers’ forward reservation prices. In addition, we also find that the market clearing forward price usually will not converge toward the expected risk-neutral forward price. The sellers’ or buyers’ risk aversion degrees and market powers are also identified to play crucial roles in determining the clearing forward price..

Keywords: House Risk, Optimal Portfolio, Forward Transactions, Utility Maximization, Incomplete Markets

JEL Classification: G1, R2

Suggested Citation

Fan, Gang-Zhi and Pu, Ming and Ong, Seow Eng, Optimal Portfolio Choices, House Risk Hedging and the Pricing of Forward House Transactions (October 8, 2009). Available at SSRN: https://ssrn.com/abstract=1485193 or http://dx.doi.org/10.2139/ssrn.1485193

Gang-Zhi Fan (Contact Author)

Beijing Normal University-Hong Kong Baptist University United International College ( email )

2000 Jintong Road
Zhuhai, Guangdong 519087
China

Ming Pu

Southwestern University of Finance and Economics (SWUFE) - Research Institute of Economics & Management ( email )

55 Guanghuacun Street
Chengdu, Sichuan 610074
China

Seow Eng Ong

affiliation not provided to SSRN ( email )