Asset Price Risk and Rent Risk: A Model for Homeownership

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Recommended: advantages and disadvantages for renting and owning

Houses provide a constant, continuous flow of housing services, so the present value is equitable to the money saved valued in spot rents:

The risk premium for households that choose to rent, πR, measures the total risk of CR, the cost of renting, emerging from the succession of annual shocks in spot rents. It maintains a positive relation to the equilibrium house price; if rent risk premium πR increases, the price in equilibrium will increase as the decision to own now provides the household with a greater benefit, also increasing the demand for homeownership.
The risk premium for homeownership, πO, measures CO, the cost of owning. Not alike the rent risk premium, the homeowner risk premium holds a negative relation to the equilibrium house price. Homeowners are subject to asset price risk, reducing the demand for homeownership.
In consideration of the simplest case, allowing for rent shocks to lack persistency ( ), rents are not spatially correlated ( ), and represents household risk aversion, the rent risk premium can be approximated by:

The early rent shocks are more heavily discounted, and the risk premium for renting increases as shocks in rent become more persistent ( ) or more spatially correlated ( ). The risk premium for owning is the total asset price risk from future housing transactions: the sale of the first unit A, the subsequent purchase of the second unit B, and later the sale of B, with and :

Contemporaneous shocks these three future house prices. also factors in the demand for homeownership. We know that as the spatial correlation or expected horizon N get larger, the demand for homeownership generally increases, while other premiums that are indirectly realized in through future sale and purcha...

... middle of paper ...

...s and expected horizons that are adequately long enough, homeownership becomes the less risky decision. The conventional wisdom that defies that renting households accept more risk than those that buy could alter the mindset that many young households acquire when first finding and making decisions about their own housing services. The model empirically analyzes published data, but factors like rent volatility could possibly carry dependence on other, less measurable standards. Nonetheless, it holds true for the purposes presented in this paper, and the implications predicted by the model were supported by empirical evidence gathered from accurate data using reputable sources.

Works Cited

Sinai, Todd, Souleles, Nicholas S. 1/27/14. “Owner-Occupied Housing as a Hedge against Rent
Risk.” The Quarterly Journal of Economics, Vol. 120, No. 2 (May, 2005), pp. 763-789

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