Housing Collateral, Consumption Insurance and Risk Premia

In a model with housing collateral, the ratio of housing wealth to human wealth shifts the conditional distribution of asset prices and consumption growth. A decrease in house prices reduces the collateral value of housing, increases household exposure to idiosyncratic risk, and increases the conditional market price of risk. Using aggregate data for the US, we find that a decrease in the ratio of housing wealth to human wealth predicts higher returns on stocks. Conditional on this ratio, the covariance of returns with aggregate risk factors explains up to eighty percent of the cross-sectional variation in annual size and book-to-market portfolio returns. Regional risk-sharing patterns for US metropolitan areas lend direct support to the housing collateral channel. In times with a high housing collateral ratio, consumption growth is more strongly correlated across regions. Time-variation in the degree of risk-sharing induced by house price changes sheds new light on the consumption correlation puzzle. ∗First version August 2002. The authors thank Andrew Abel, Fernando Alvarez, Andrew Atkeson, Patrick Bajari, Timothey Cogley, Harold Cole, Marco Del Negro, Steven Grenadier, Robert Hall, Lars Peter Hansen, Christobal Huneuus, Kenneth Judd, Narayana Kocherlakota, Dirk Krueger, Sydney Ludvigson, Sergei Morozov, Lee Ohanian, Monika Piazzesi, Luigi Pistaferri, Esteban Rossi-Hansberg, Thomas Sargent, Kenneth Singleton, Laura Veldkamp, Pierre-Olivier Weill, Amir Yaron and the participants of the 2002 LA econometric Society Meeting, the NY Society for Economic Dynamics Conference, the Stanford macroeconomics seminar, the Money and Banking workshop at the University of Chicago and the macrolunch at UCLA for valuable comments. Stijn Van Nieuwerburgh is grateful for advice from Robert Hall and Dirk Krueger and for advice and support throughout the length of the project from Thomas Sargent. Stijn Van Nieuwerburgh acknowledges financial support from the Stanford Institute for Economic Policy research and the Flanders Fund for Scientific Research.