Local House Price Paths: Accelerations, Declines, and Recoveries
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Mortgage credit risk measurement hinges on the choice of a house price stress path, which is used to project loan losses and determine financial capital requirements. House price paths are commonly constructed at national or state levels and shock scenarios are created to mimic historical adverse market conditions. We provide evidence that this level of geographic aggregation is not granular enough in many cases—collateral risk often varies within cities. Using local house price indices that cover the United States from 1975 to 2016, we focus on house price performance in the years immediately following sustained periods of rapid acceleration. Price accelerations tend to exhibit temporal clustering and occur with greater frequency in large versus small cities. We exploit within-city variation in price dynamics to provide evidence that price initially overshoot sustainable levels but, in some areas, dynamics may reflect positive underlying economic fundamentals and can be sustained. After accelerating, price reach their trough after 4 or 5 years. Small cities show uniform declines whereas large cities exhibit greater price decreases farther away from city centers. These findings suggest differential collateral risk exists in large cities, financial losses can be predictable based on real estate location theory, and localized house price paths could aid credit risk management.
KeywordsHouse price cycles Credit risk Mortgage collateral Stress testing
The authors are grateful for thorough and constructive suggestions provided by an anonymous reviewer. They also thank Andy Leventis, Tony Yezer, and seminar participants at the Department of Housing and Urban Development, Freddie Mac, and the AREUEA mid-year meetings, who provided helpful questions, comments, and discussion. The analysis and conclusions are those of the authors and do not necessarily represent the views of the Federal Housing Finance Agency or the United States.
Compliance with Ethical Standards
The authors declare that they have no conflict of interest and no outside funding was received.
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