Housing Risk and the Cross-Section of Returns Across Many Asset Classes

Abstract

When households consume both nondurable goods and housing services, external habit preference over nondurable consumption generates procyclical demand for housing. Marginal utility falls when housing demand rises and innovations to housing demand arise as a risk factor. Motivated by theory, we use shocks to the ratio of residential-to-aggregate investment to capture the housing demand risk. The single-factor model exhibits strong explanatory power for expected returns across various equity characteristic-sorted portfolios and non-equity asset classes with positive risk price estimates that are similar in magnitude. The model is robust to controlling for other factor models based on durable consumption, financial intermediaries, household heterogeneity, and return-based multifactor models designed to price these assets.

Keywords: asset classes, cross section, risk, housing, demand shocks

JEL Classification: G10, G11, G12