Advertisement

Stabilising House Prices: the Role of Housing Futures Trading

  • Arzu Uluc
Article

Abstract

This study investigates the effects of housing futures trading on housing demand, house price volatility and housing bubbles in a theoretical framework. The baseline model is an application of the De long, Shleifer, Summers and Waldman (1990) model of noise traders to the housing market, when the risky asset is housing. This adds new features to the model as households receive utility from housing services and cannot short-sell houses. The existence of noise traders in the housing market creates uncertainty about house prices, causes prices to deviate away from their fundamental values, and leads to a distortion in housing consumption. To investigate the impact of housing derivatives trading on the housing market, a new financial instrument, housing futures, is introduced into the baseline model. Housing futures trading affects house price stability through three channels: by (i) enabling households to disentangle their housing consumption decisions from investment decisions; (ii) allowing short-selling; and (iii) attracting an additional set of traders (pure speculators) looking for portfolio diversification opportunities. The results show that, for a large set of admissible parameter values, housing futures trading decreases the volatility of house prices and increases the welfare of households and investors.

Keywords

Housing derivatives market Speculation House price volatility Short-selling Noise traders 

Notes

Acknowledgements

This paper is a chapter of my PhD dissertation at European University Institute. I am indebted to Russell Cooper, Nicola Gennaioli, Ramon Marimon and Jaume Ventura for their continuous advise and comments.

Compliance with Ethical Standards

Conflict of interests

The author declares that she has no conflict of interest.

References

  1. Abreu, D., & Brunnermeier, M.K. (2003). Bubbles and crashes. Econometrica, 71(1), 173–204.CrossRefGoogle Scholar
  2. Allen, F., & Gorton, G. (1993). Churning bubbles. Review of Economic Studies, 60(4), 813–36.CrossRefGoogle Scholar
  3. Allen, F., Morris, S., & Postlewaite, A. (1993). Finite bubbles with short sale constraints and asymmetric information. Journal of Economic Theory, 61(2), 206–229.CrossRefGoogle Scholar
  4. Bertus, M., Hollans, H., & Swidler, S. (2008). Hedging house price risk with cme futures contracts: The case of las vegas residential real estate. The Journal of Real Estate Finance and Economics, 37, 265–279.CrossRefGoogle Scholar
  5. Blanchard, O.J., & Watson, M.W. (1982). Bubbles, rational expectations, and financial markets. In Wachtel, P. (Ed.) Crisis in the economic and financial structure. Lexington.Google Scholar
  6. Caplin, A., Chan, S., Freeman, C., & and Tracy, J. (1997). Housing partnerships: A new approach to a market at a crossroads, Vol. 1 of MIT Press Books. The MIT Press.Google Scholar
  7. Case, K.E., & Shiller, R.J. (1989). The efficiency of the market for single-family homes. American Economic Review, 79(1), 125–37.Google Scholar
  8. Case, K.E., Shiller, R.J., & Weiss, A.N. (1993). Index-based futures and options markets in real estate. Journal of Portfolio Management, 19(1), 83–92.CrossRefGoogle Scholar
  9. Chambers, M., Garriga, C., & Schlagenhauf, D.E. (2009). Accounting for changes in the homeownership rate. International Economic Review, 50(3), 677–726.CrossRefGoogle Scholar
  10. Chari, V.V., Jagannathan, R., & Jones, L. (1990). Price stability and futures trading in commodities. The Quarterly Journal of Economics, 105(2), 527–534.CrossRefGoogle Scholar
  11. Danthine, J.-P. (1978). Information, futures prices, and stabilizing speculation. Journal of Economic Theory, 17(1), 79–98.CrossRefGoogle Scholar
  12. De Jong, F., Driessen, J., & Van Hemert, O. (2008). Hedging house price risk: Portfolio choice with housing futures. Working paper, Social Science Research Network.Google Scholar
  13. De Long, J.B., Shleifer, A., Summers, L.H., & Waldmann, R.J. (1990). Noise trader risk in financial markets. Journal of Political Economy, 98(4), 703–38.CrossRefGoogle Scholar
  14. Demers, F., & Demers, M. (1989). A privately revealing rational expectations equilibrium for the futures market. European Economic Review, 33(4), 663–685.CrossRefGoogle Scholar
  15. Englund, P. (2010). Trading on home price risk: Index derivatives and home equity insurance. In Smith, S.J., & Searle, B. (Eds.), The economics of housing: The housing wealth of nations, chapter 21: Wiley-Blackwell.Google Scholar
  16. Englund, P., Hwang, M., & Quigley, J.M. (2002). Hedging housing risk. The Journal of Real Estate Finance and Economics, 24(1-2), 167–200.CrossRefGoogle Scholar
  17. Fan, G. -Z., Pu, M., & Ong, S. (2012). Optimal portfolio choices, house risk hedging and the pricing of forward house transactions. The Journal of Real Estate Finance and Economics, 45(1), 3–29.CrossRefGoogle Scholar
  18. Feder, G., Just, R.E., & Schmitz, A. (1980). Futures markets and the theory of the firm under price uncertainty. The Quarterly Journal of Economics, 94(2), 317–28.CrossRefGoogle Scholar
  19. Halket, J., & Vasudev, S. (2012). Home ownership, savings, and mobility over the life cycle. Economics Discussion Papers 712, University of Essex, Department of Economics.Google Scholar
  20. Harrison, J.M., & Kreps, D.M. (1978). Speculative investor behavior in a stock market with heterogeneous expectations. The Quarterly Journal of Economics, 92 (2), 323–36.CrossRefGoogle Scholar
  21. Henderson, J.V., & Ioannides, Y.M. (1983). A model of housing tenure choice. American Economic Review, 73(1), 98–113.Google Scholar
  22. Holthausen, D.M. (1979). Hedging and the competitive firm under price uncertainty. American Economic Review, 69(5), 989–995.Google Scholar
  23. Iacoviello, M., & Ortalo-Magne, F. (2003). Hedging housing risk in london. The Journal of Real Estate Finance and Economics, 27(2), 191–209.CrossRefGoogle Scholar
  24. Kawai, M. (1983). Price volatility of storable commodities under rational expectations in spot and futures markets. International Economic Review, 24(2), 435–59.CrossRefGoogle Scholar
  25. Lee, C., Stevenson, S., & Lee, M. -L. (2014). Futures trading, spot price volatility and market efficiency: Evidence from european real estate securities futures. The Journal of Real Estate Finance and Economics, 48(2), 299–322.CrossRefGoogle Scholar
  26. Martin, A., & Ventura, J. (2012). Economic growth with bubbles. American Economic Review, 102(6), 3033–58.CrossRefGoogle Scholar
  27. Miller, E.M. (1977). Risk, uncertainty, and divergence of opinion. Journal of Finance, 32(4), 1151–68.CrossRefGoogle Scholar
  28. Newbery, D.M. (1987). When do futures destabilize spot prices? International Economic Review, 28(2), 291–97.CrossRefGoogle Scholar
  29. Oh, G. (1996). Some results in the capm with nontraded endowments. Management Science, 42(2), 286–293.CrossRefGoogle Scholar
  30. Samuelson, P.A. (1958). An exact consumption-loan model of interest with or without the social contrivance of money. Journal of Political Economy, 66, 467.CrossRefGoogle Scholar
  31. Santos, M.S., & Woodford, M. (1997). Rational asset pricing bubbles. Econometrica, 65(1), 19–58.CrossRefGoogle Scholar
  32. Sarris, A.H. (1984). Speculative storage, futures markets, and the stability of commodity prices. Economic Inquiry, 22(1), 80–97.CrossRefGoogle Scholar
  33. Scheinkman, J.A., & Xiong, W. (2003). Overconfidence and speculative bubbles. Journal of Political Economy, 111(6), 1183–1219.CrossRefGoogle Scholar
  34. Shiller, R.J. (2007). Understanding recent trends in house prices and home ownership. NBER Working Papers 13553, National Bureau of Economic Research, Inc.Google Scholar
  35. Shiller, R.J. (2008). Derivatives markets for home prices. NBER Working Papers 13962, National Bureau of Economic Research, Inc.Google Scholar
  36. Shleifer, A., & Vishny, R.W. (1997). The limits of arbitrage. Journal of Finance, 52(1), 35–55.CrossRefGoogle Scholar
  37. Stein, J.C. (1987). Informational externalities and welfare-reducing speculation. Journal of Political Economy, 95(6), 1123–45.CrossRefGoogle Scholar
  38. Tirole, J. (1985). Asset bubbles and overlapping generations. Econometrica, 53(6), 1499–1528.CrossRefGoogle Scholar
  39. Turnovsky, S.J. (1983). The determination of spot and futures prices with storable commodities. Econometrica, 51(5), 1363–87.CrossRefGoogle Scholar
  40. Voicu, C., & Seiler, M.J. (2013). Deriving optimal portfolios for hedging housing risk. The Journal of Real Estate Finance and Economics, 46(1), 379–396.CrossRefGoogle Scholar
  41. Wong, S., Yiu, C., Tse, M., & Chau, K. (2006). Do the forward sales of real estate stabilize spot prices? The Journal of Real Estate Finance and Economics, 32 (3), 289–304.CrossRefGoogle Scholar
  42. Wong, S., Chau, K., & Yiu, C. (2007). Volatility transmission in the real estate spot and forward markets. The Journal of Real Estate Finance and Economics, 35(3), 281–293.CrossRefGoogle Scholar

Copyright information

© Springer Science+Business Media New York (outside the USA) 2017

Authors and Affiliations

  1. 1.Bank of EnglandLondonUK

Personalised recommendations