Owner-Occupied Housing as a Hedge Against Rent Risk

45 Pages Posted: 31 Jan 2003 Last revised: 10 May 2021

See all articles by Todd M. Sinai

Todd M. Sinai

University of Pennsylvania - The Wharton School; National Bureau of Economic Research (NBER)

Nicholas S. Souleles

University of Pennsylvania - Finance Department; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: January 2003

Abstract

Many people assume that the most significant risk in the housing market is that homeowners are exposed to fluctuations in house values. However, homeownership also provides a hedge against fluctuations in future rent payments. This paper finds that, even though house price risk endogenously increases with rent risk, the latter empirically dominates for most households so housing market risk actually increases homeownership rates and house prices. Further, the net effect of rent risk on the demand for homeownership increases with a household's expected length of stay in its home, as the cumulative rent volatility rises and the discounted house price risk falls. Using CPS data, the difference in the probability of homeownership between households with long and short expected lengths of stay is 2.9 to 5.4 percentage points greater in high rent variance places than low rent variance places. The sensitivity to rent risk is greatest for households that devote a larger share of their budgets to housing, and thus face a bigger gamble. Similarly, the elderly who live in high rent variance places are more likely to own their own homes, and their probability of homeownership falls faster with age (as their horizon shortens). This aversion to rent risk might help explain why older households do not consume much of their housing wealth. Finally, we find that house prices capitalize not only expected future rents, but also the associated rent risk premia. At the MSA level, a one standard deviation increase in rent variance increases the house price-to-rent ratio by 2 to 4 percent.

Suggested Citation

Sinai, Todd M. and Souleles, Nicholas S., Owner-Occupied Housing as a Hedge Against Rent Risk (January 2003). NBER Working Paper No. w9462, Available at SSRN: https://ssrn.com/abstract=375314

Todd M. Sinai (Contact Author)

University of Pennsylvania - The Wharton School ( email )

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HOME PAGE: http://real.wharton.upenn.edu/~sinai

National Bureau of Economic Research (NBER)

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Nicholas S. Souleles

University of Pennsylvania - Finance Department ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States
215-898-9466 (Phone)
215-898-6200 (Fax)

HOME PAGE: http://finance.wharton.upenn.edu/~souleles

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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