Idiosyncratic Risk in Housing Markets

Abstract

This paper studies the idiosyncratic risk component of individual house capital gains, using data on resales and intermediate capital investments. The idiosyncratic component is large, its dynamics do not follow a random walk, and its magnitude is associated with proxies of information quality and market liquidity at the level of individual properties. Accounting for idiosyncratic risk substantially changes the assessment of the risk-return trade-off for housing, reducing Sharpe ratios and making them holding period-dependent. I use a simple quantitative portfolio model to show that homeowners may be willing to make significant payments to insure against idiosyncratic housing risk.

Keywords: Idiosyncratic Risk, Housing, Liquidity, Homeownership

JEL Classification: G1, R0, D0