Essays on housing and real economy

                                               Acknowledgements I owe an enormous debt of gratitude to my supervisor, Associate Professor Sing Tien Foo for his support, guidance and encouragement throughout the Ph.D. program. His gentle personality and meticulous attitude to research will bene…t my career as well as personal life. Special thanks to Dr. Liao Wen-chi, who gives me a lot of help on my research, especially for Chapter 3. Great thankfulness is expressed to Associate Professor Fu Yuming, Associate Professor Yu Shi Ming, Associate Professor Tu Yong, Professor Ong Seow Eng, Professor Deng Yongheng, Dr. Lee Nai Jia, Dr. Li Nan, Dr. Seah Kiat Ying, Dr. Li Pei, Dr. Qian Wenlan, Professor James D. Shilling, Dr. Chu Yongqiang for their helpful comments, suggestions and discussions on my thesis and general academic career. I am grateful for helpful comments from the participants at the Asian Real Estate Society annual conference 2010, Paci…c Rim Real Estate Society annual conference 2012, and Global Chinese Real Estate Congress annual conference 2012. I would like to thank all of my postgraduate peers. I enjoyed sharing ideas and developing my research by conversing with them. They are included but not limited: Wong Woei Chyuan, Omokolade Ayodeji Akinsomi, Liu Bo, Shen Huaisheng, Li Mu, Wei Yuan, Liang Lanfeng, Xu Yiqin, Zhang Huiming, Shen i ACKNOWLEDGEMENTS ii Yinjie, Liu Jingran, Peng Siyuan, Jiang Yuxi, Chen Wei, Wang Yourong, Guo Yan, Li Qing, Radheshyam Chamarajanagara Gopinath, and etc. I would also like to thank the administrative sta¤ members, Zainab Bte Abdul Ghani, Zheng Huiming, Nor’aini Bte Ali, Wong Mei Yin, Ko Chen, who were so instrumental in helping me get things done smoothly. Generous …nancial support from National University of Singapore is highly appreciated. Finally, I thank my family, particularly my wife, Qiu Leiju, who has been unconditional supportive and encouraging during the course of my study. Contents Acknowledgements i Summary vi Introduction 1.1 Research Background . . . . . . . . . . . . . . . . . . . . . . . . . . 1.2 Overview of the Research . . . . . . . . . . . . . . . . . . . . . . . . 1.3 Signi…cance of the Research . . . . . . . . . . . . . . . . . . . . . . 1.4 Organization of the Thesis . . . . . . . . . . . . . . . . . . . . . . . Housing, Wealth Composition and Expected Stock Return 2.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 2.2 Related Literature . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 2.3 Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 2.3.1 Environment and Preferences . . . . . . . . . . . . . . . . . 19 2.3.2 Housing Market . . . . . . . . . . . . . . . . . . . . . . . . . 21 2.3.3 Pricing Kernel . . . . . . . . . . . . . . . . . . . . . . . . . . 23 2.4 Data and Measurement . . . . . . . . . . . . . . . . . . . . . . . . . 25 2.4.1 Measurement of Housing-Financial Wealth Ratio 2.4.2 Consumption Data . . . . . . . . . . . . . . . . . . . . . . . 30 iii . . . . . . 26 CONTENTS iv 2.4.3 Financial Data . . . . . . . . . . . . . . . . . . . . . . . . . 32 2.5 Long-horizon Forecasts . . . . . . . . . . . . . . . . . . . . . . . . . 33 2.6 Cross-Sectional Test of the Linear Factor Model . . . . . . . . . . . 37 2.6.1 The Linear Factor Model and Fama-MacBeth Procedure . . 37 2.6.2 Results from Fama-MacBeth Procedure . . . . . . . . . . . . 39 2.6.3 Sensitivity Analysis . . . . . . . . . . . . . . . . . . . . . . . 45 2.6.4 Time-varying Consumption Betas . . . . . . . . . . . . . . . 47 2.7 Micro Evidence from Subprime Crisis . . . . . . . . . . . . . . . . . 52 2.7.1 Time-varying Stock Market Participation . . . . . . . . . . . 53 2.7.2 Determinants of Distress . . . . . . . . . . . . . . . . . . . . 55 2.7.3 Consequence of Distress . . . . . . . . . . . . . . . . . . . . 58 2.8 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60 2.9 Appendix: Panel Study of Income Dynamics (PSID) Data . . . . . 61 Risk Attitude and Housing Wealth E¤ect 65 3.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65 3.2 Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69 3.3 Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 76 3.4 Empirical Tests and Results . . . . . . . . . . . . . . . . . . . . . . 80 3.4.1 Estimate Risk Attitude . . . . . . . . . . . . . . . . . . . . . 81 3.4.2 Estimate HWE by Risk Attitude . . . . . . . . . . . . . . . 87 3.5 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94 3.6 Appendix . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97 3.6.1 Descriptive Statistics of Risky Assets Holding . . . . . . . . 97 3.6.2 First Step Probit Model of Heckman Correction . . . . . . . 97 Consumption and Wealth Accumulation over the Life Cycle: Does CONTENTS v Down Payment Matter? 100 4.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100 4.2 Stylized Facts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105 4.3 Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 109 4.3.1 Demographics . . . . . . . . . . . . . . . . . . . . . . . . . . 109 4.3.2 Technology . . . . . . . . . . . . . . . . . . . . . . . . . . . 109 4.3.3 Preferences . . . . . . . . . . . . . . . . . . . . . . . . . . . 110 4.3.4 Endowments . . . . . . . . . . . . . . . . . . . . . . . . . . . 111 4.3.5 Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111 4.3.6 Timing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 113 4.3.7 The Household’s Problem . . . . . . . . . . . . . . . . . . . 113 4.3.8 Equilibrium . . . . . . . . . . . . . . . . . . . . . . . . . . . 115 4.4 Calibration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 116 4.5 Results . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 118 4.6 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 123 4.7 Appendix . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 123 4.7.1 Life-cycle Wealth and Non-housing Consumption . . . . . . 123 4.7.2 Numerical Computation Algorithm . . . . . . . . . . . . . . 125 Conclusion 127 5.1 Summary of Main Findings . . . . . . . . . . . . . . . . . . . . . . 127 5.2 Policy Implication . . . . . . . . . . . . . . . . . . . . . . . . . . . . 130 5.3 Limitation and Future Work . . . . . . . . . . . . . . . . . . . . . . 131 Summary This thesis focuses on issues related to the roles of housing in real economy. Housing is the single most important consumption good, and the dominate wealth for households. The unique characteristic in‡uences the behavior of households in terms of consumption, saving, mortgage issuance, and asset return. This thesis is composed of three main chapters. Chapter considers a consumption-based asset pricing model where housing is explicitly modelled both as an asset and a consumption good. As a consumption good, housing expenditure share is modelled as a novel risk factor. As an asset, it is the major component of wealth other than …nancial assets. The ‡uctuation of aggregate housing-…nancial wealth ratio, as a consequence of irrational housing market, impacts the budget constraints of households. It increases household’s exposure to risk and shifts the conditional distribution of consumption growth. Using the United States data, I …nd that the ‡uctuation of housing-…nancial wealth ratio is a strong predictor for the expected stock return. Conditional on this factor, the covariances of the returns with the aggregate risk factors explain a large ratio of the cross-sectional variations in annual returns of size and bookto-market portfolio. The micro mechanism of this asset pricing model is also supported by the micro data during subprime crisis. Chapter examines the housing wealth e¤ect— the positive consumption change vi SUMMARY vii induced by house price appreciation— and whether it is dependent upon households’attitude toward risk. A simple theoretical model is introduced to highlight a negative relationship between the wealth e¤ect and risk aversion. This chapter empirically tests this negative relationship, using data from the U.S. Consumer Expenditure Survey (CEX). The investigation involves two steps. In the …rst step, I make use of households’demographic and their risky and liquid asset holdings to estimate risk aversion. The Heckman correction model is applied to address the issue of limited stock market participation. In the second step, I construct pseudo panel data through grouping households by their birth years and their predicted values of risk aversion, and then, I estimate the responses of households’ consumption changes to house price ‡uctuations by di¤erent risk-attitude groups. Consistent with the prediction of the theoretical model, the estimation results suggest a signi…cant negative relationship between the housing wealth e¤ect and households’risk attitude. Households, who are less risk averse, experience greater consumption changes in response to house price appreciation. Chapter explains the in‡uences of mortgage down payment requirement in both the housing and the credit markets. The rapid expansion of mortgage credit market since the mid-1990s reduces the mortgage down payment requirement for the U.S. households. Micro data over the life cycle show that the patterns of consumption and wealth accumulation changed after the credit expansion: non-housing consumption for older household increases signi…cantly, but younger households own less wealth. This chapter develops a dynamic general equilibrium model with constant housing supply, which …nds that decreases in down payment requirement account for changes in the pro…les of consumption and wealth accumulation for households. This model also implies that decreases in down payment requirement cannot explain increases in homeownership rate since the mid-1990s. List of Tables 2.1 List of Variables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 2.2 Summary Statistics of Hostorical Data . . . . . . . . . . . . . . . . 31 2.3 Long-Horizon Predictability Regressions . . . . . . . . . . . . . . . 36 2.4 Fama-Macbeth Regression Results . . . . . . . . . . . . . . . . . . . 40 2.5 Comparison of Asset Pricing Models . . . . . . . . . . . . . . . . . 42 2.6 Cross-Sectional Results with Lagged Consumption . . . . . . . . . . 46 2.7 Cross-Sectional Results with Lagged Housing-Financial Wealth Ratio 48 2.8 Cross-Sectional Results with Overlapped Return . . . . . . . . . . . 49 2.9 Consumption Beta . . . . . . . . . . . . . . . . . . . . . . . . . . . 51 2.10 Time-varying Stock Market Participation and Foreclosure . . . . . . 53 2.11 Logit Regression on Determinants of Distress . . . . . . . . . . . . . 56 2.12 Stock Market Participation by Di¤erent Types Families . . . . . . . 58 2.13 Test of Consumption Insurance . . . . . . . . . . . . . . . . . . . . 59 2.14 Descriptive Statistics of PSID Data . . . . . . . . . . . . . . . . . . 64 3.1 Benchmark Values of Parameters . . . . . . . . . . . . . . . . . . . 74 3.2 Regression of Risky Asset Composition on Demographics . . . . . . 84 3.3 Cohort Regression of Consumption Change by Risk Attitude . . . . 93 3.4 Comparison of The Housing Wealth E¤ect across Risk Attitude Groups . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94 viii BIBLIOGRAPHY 135 [15] Bertaut, Carol C., and Martha Starr-McCluer, 2002, Household portfolios in the united states, in Luigi Guiso, Michael Haliassos, and Tullio Jappeli, eds.: Household portfolios (MIT Press, Cambridge). 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[...]... growth, such as the standard deviation and the skewness, reduces the size of the Euler equation errors for the stock return Lettau and Ludvigson (2001a, b) empirically show that the ratio of consumption to wealth predicts the asset returns and conditional versions of CCAPM conditioning on the ratio of consumption to wealth perform much better than the unconditional versions Santos and Veronesi (2006) incorporate... considers the dual-role of housing both consumption and investment goods — into consumption sector A consumption based asset pricing model, a typical household consumption model and a general equilibrium model are proposed in this dissertation respectively to describe the impacts of housing on real economy It potentially contributes to the current …nance, macroeconomic and real estate literature To... my research, and I propose a consumption based asset pricing model, a typical household consumption model and a general equilibrium model in the following three main chapters respectively They describe di¤erent impacts of housing on real economy Chapter 2 extends the consumption-based asset pricing model, where housing is considered as both consumption and wealth composition As consumption goods, 5... The model includes a continuous of in…nitely lived heterogeneous households who consume nondurable consumption and housing service Housing plays a dual-role in the model as both a consumption good and an investment good The irrational activity of housing market breaks the assumption of full consumption insurance and changes the distribution of consumption growth in the cross-section, which creates a... CHAPTER 1 INTRODUCTION 4 higher collateral value and therefore relax borrowing constraints5 Housing wealth indirectly a¤ects non -housing consumption through the collateral channel Since housing wealth and consumption have considerable weight in real economy, housing can play a role of media during economic cycle Business downturn deteriorate asset values, reduce debt capacity and depress investment,... literature, the housing researches now expand to a wider scope The frontier research on housing covers three aspects Firstly, the performance of housing market can be taken as a sensitive indicator of economy As Leamer (2007) said housing is the business cycle” economic statistics show , strong correlations between the housing variables (e.g residential investment, housing consumption, housing price) and the... through housing market during and after this recession (e.g Mian and Su…, 2010; Mian, Su…, and Trebbi, 2011) 1.2 Overview of the Research In line with above cutting-edge researches, I discuss the linkage between housing and real economy in this dissertation In my study, housing is modeled into the utility function of household; and also considered in the budget constraint at the same time Housing plays... Chomsosengphet and Pennington-Cross, 2006; Mayer and Pence, 2008; Greenspan and Kennedy, 2008) To macroeconomic literature, it considers that the households’ consumption behavior over life cycle and how they response to the shock from housing market and credit market It is related to a growing literature on how durable goods a¤ect the households’consumption over life cycle (See Cho and Sane 2006; FernandezVillaverde... market on the stock market The impacts of increasing housing prices on non -housing consumption are examined in Chapter 3, entitled “Risk Attitude and Housing Wealth E¤ect” Chapter 4 presents the third story, entitled “Consumption and Wealth Accumulation over the Life Cycle: Does Down Payment Matters? ” This chapter investigates the consumption and saving behaviors of households over the cycle corresponding... …nds a signi…cant relationship between irrational housing market and risk premia Risk premia of consumption growth in a hot housing market is higher The consumption betas are time-varying Conditional on the wealth composition, the covariances of returns with aggregate risk factors explain 80% of the crosssectional variation in annual size and book-to-market portfolio returns Housing plays a dual-role . impacts of housing on real economy. Chapter 2 extends the consumption-based asset pricing model, where housing is considered as both consumption and wealth composition. As consumption goods, 5 This. a¤ects non -housing consumption through the collateral channel. Since housing wealth and consumption have considerable weight in real econ- omy, housing can play a role of media during economic. between housing and real economy in this dissertation. In my study, housing is modeled into the utility function of household; and also considered in the budget constraint at the same time. Housing