Does Collateral Value Affect Asset Prices? Evidence from a Natural Experiment in Texas

Abstract

Does the ability to pledge an asset as collateral, after purchase, affect its price? This paper identifies the impact of collateral service flows on house prices, exploiting a plausibly exogenous constitutional amendment in Texas which legalized home equity loans in 1998. The law change increased Texas house prices 4%; this is price-based evidence that households are credit-constrained and value home equity loans to facilitate consumption smoothing. Prices rose more in locations with inelastic supply, higher pre-law house prices, higher income, and lower unemployment. These estimates reveal that richer households value the option to pledge their home as collateral more strongly.

Keywords: Asset Pricing, Real Estate, real options, home equity, housing collateral, liquidity constraints, household consumption and saving decisions, leverage

JEL Classification: R0, R3, G0, E21, E44, G2