1204 words - 5 pages

Rent risk may veritably carry more risk than the common presumption of the risks associated with homeownership. University of Pennsylvania Wharton School professors Todd Sinai and Nicholas S. Souleles introduce a model of tenure choice that takes into consideration the rent volatility, a household’s expected length of stay (a household’s expected horizon), the correlation in future housing prices, and evaluates the demand for owning through rent risk and asset price risk.

Renters are subject to annual fluctuations in rent, but do not incur the asset price risk that homeowners carry. On the other hand, households that own their houses enjoy a known, up-front expenditure; the purchase price. ...view middle of the document...

The volatility of rent is calculated through the difference between the actual log of rent and the average growth rate of rent. Demographic information on households and homeownership was taken from the 1990-1999 Current Population Survey, excluding any households that were located outside of the 44 metropolitan statistical areas or were missing information. Sixty percent of these households are homeowners, and paid on average sixteen times the average rent across the metropolitan statistical areas. The expected horizons of households are derived for the elderly from age, and for the general population from the probability of not moving in a given year.

Homeownership incurs asset price risk, and on average the house comprises approximately 27% of net worth for most. Thus, fluctuations in value can have a detrimental effect on a homeowner’s balance sheet; however a home is not a typical financial asset. It is a necessity, and the risk in shifts in asset prices over time are perceived only when the household moves and sells the home at a future sales price; moving will inevitably occur on account of the fact that houses outgrow the length of expected horizons in their home. Thus, a household’s entire risk position, for both renters and owners alike, considers both asset price risk and rent risk.

The expected horizon and correlation of future housing markets determine which of the two risks are dominant. For households with longer horizons, rent risk is more prone to be dominant. A larger quantity of fluctuations in rent also increases volatility. Asset price risk decreases as the time of perceiving the risk is pushed further into the future, increasing the demand for ownership. Thus, homeownership is used as a hedge against both rent and asset price risk. For these households with longer expected horizons, the weight of the increase experienced in ownership demand will increase volatility in rents. This corresponds with empirical evidence in data on metropolitan statistical areas. In addition, household data holds that the probability of homeownership increases more quickly with rent volatility for longer-horizon households than for shorter-horizon households. Asset price risk dominates if horizons do not last long enough to be affected by rent risk and there exists a lack of correlation between the current and future location’s house prices.

The trade-off between rent risk and asset price risk varies with the expected horizon, rent volatility and spatial correlation amongst the housing markets, the net risk declining with the household’s horizon. Demand for homeownership should...

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