Stabilising House Prices: The Role of Housing Futures Trading

41 Pages Posted: 14 Oct 2015 Last revised: 17 Oct 2015

Multiple version iconThere are 2 versions of this paper

Date Written: October 9, 2015

Abstract

This study investigates the effects of housing futures trading on housing demand, house price volatility and housing bubbles in a theoretical framework. The baseline model is an application of the De Long, Shleifer, Summers and Waldmann (1990) model of noise traders to the housing market, when the risky asset is housing. This adds new features to the model as households receive utility from housing services and cannot short-sell houses. The existence of noise traders in the housing market creates uncertainty about house prices, causes prices to deviate away from their fundamental values, and leads to a distortion in housing consumption. To investigate the impact of housing derivatives trading on the housing market, a new financial instrument, housing futures, is introduced into the baseline model. Housing futures trading affects house price stability through three channels: by (i) enabling households to disentangle their housing consumption decisions from investment decisions; (ii) allowing short-selling; and (iii) attracting an additional set of traders (pure speculators) looking for portfolio diversification opportunities. The results show that, for a large set of admissible parameter values, housing futures trading decreases the volatility of house prices and increases the welfare of households and investors when noise trader (sophisticated) households are always relatively optimistic (pessimistic), and the share of pure speculators that are sophisticated is higher than the share of households that are sophisticated.

Keywords: Housing derivatives market, speculation, house price volatility, short-selling, noise traders

JEL Classification: G13, R21

Suggested Citation

Uluc, Arzu, Stabilising House Prices: The Role of Housing Futures Trading (October 9, 2015). Bank of England Working Paper No. 559, Available at SSRN: https://ssrn.com/abstract=2674116 or http://dx.doi.org/10.2139/ssrn.2674116

Arzu Uluc (Contact Author)

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

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