Hedging Home Equity Risk: Examination of a Nobel Idea

Abstract

Robert Shiller has long advocated the use of derivative real estate instruments to manage home equity risk. While his Nobel idea discusses the benefits to homeowners, to date, practical issues of hedging have been largely unexplored. Starting with the 2006 listing of real estate futures contracts on the Chicago Mercantile Exchange (CME), we examine transaction data from Las Vegas and consider several futures and index hedging strategies. The results indicate that idiosyncratic risk is large and renders hedging strategies ineffective for many homeowners that lost money on the sale of their house during the financial crisis. The set of results include certain holding periods where hedge payouts are only a small fraction of their home equity losses and still other times when an individual would lose both on their home sale and on their derivatives position. Thus, while home equity risk management is a Nobel idea, in practice, it is difficult to do.

Keywords: Home equity risk, house price risk, hedging, real estate futures contracts

JEL Classification: G01, G13, R21, R30