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Title: Understanding the Puzzling Risk-Return Relationship for Housing

Citation Type: Miscellaneous

Publication Year: 2010

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Abstract: Standard theory predicts a positive relationship between risk and return, yet recent house price data show thathousing returns vary positively with risk in some metropolitan areas but negatively in others. This paper rationalizescross-market di erences in the risk-return relationship for housing, and in so doing, explains the puzzling negativerelationship. The paper's explanation emphasizes the interaction of three local market factors: households' hedgingincentives, housing supply constraints, and urban market growth. Using a simple conceptual framework, I show thathouseholds are willing to accept a lower return to compensate for price risk when the current house provides a hedgeagainst future housing consumption risk. This hedging e ect is mitigated, however, by increased construction whenhousing supply is elastic and urban growth is su$ciently high. Consistent with these predictions, I nd evidence thatin markets where hedging incentives are su$ciently strong, there tends to be a negative risk-return relationship.Furthermore, the impact of hedging on the risk-return relationship is stronger in markets where housing supplyis more constrained. Finally, these hedging and supply-constraint e ects appear only in growing markets wherepopulation growth is su$ciently high.Keywords: Risk-return relationship; Housing; Geographical Variation; Hedging; Supply constraints; Urbangrowth

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Authors: Han, Lu

Publisher: University of Toronto

Data Collections: IPUMS USA

Topics: Housing and Segregation

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