Is It Possible to Construct Derivatives for the Paris Residential Market?

Index-based derivatives markets are fast developing in Europe, the US and Asia. Both valuation based and transactions based indices are used as bases for these derivatives contracts. This paper addresses the issue of revision effects on key index parameters, and their implications for derivatives pricing and questions whether these indices may be suitable for derivatives. More specifically, we address the issue of the robustness of the price level, mean, and volatility estimates for two repeat sales real estate price indices: the classical Weighted Repeat Sales (WRS) method and a Principal Component Analysis (PCA) factorial method, as elaborated in Baroni et al. (J Real Estate Res, 29(2):137–158, 2007). Our work is an extension of Clapham et al. (Real Estate Econ, 34(2):275–302, 2006), with the aim of helping judge the efficiency of such indices in designing real estate derivatives. We use an extensive repeat sales database for the Paris (France) residential market. We describe the dataset used and compute the parameters (index price level, trend and volatility) of the indices produced over the period 1982–2005. We then test the sensitivity of these two indices to revisions due to additional repeat-sales transactions information. Our analysis is conducted on the overall Paris market as well as on sub-markets. Our main conclusion is that even if the revision problem may cause substantial concern for the stability of key parameters that are used as inputs in the pricing of derivatives contracts, the order of magnitude of revision on derivatives pricing is not sufficient to deter market participants when it comes to products such a swap contract or insurance contracts against severe losses. We also show that WRS and PCA react differently to revision. The impact of index revision is non negligible in estimating the index price level for both indices. This result is consistent with existing literature for the US and Swedish markets. Price level revision causes moderate concern when trading products such as index futures or price insurance contracts, but could deter option like products. We show that managing this price level revision risk is similar to delta hedging in standard option pricing theory. We also find that although revision impact on index trend can be important, the WRS method seems more robust than PCA. However, the trend revision impact order of magnitude for contracts such as total return swaps is low. Finally, revision influence on volatility estimates seems to have a modest impact on derivatives, and according to the robustness of the volatility estimate, the PCA factorial index seems to fare relatively better than the WRS index. Hence, our findings show that the factorial index could better sustain volatility based derivatives. We also show that whatever the index, managing this volatility revision risk is similar to vega hedging in option pricing theory.

Hedging House Price Risk with CME Futures Contracts: The Case of Las Vegas Residential Real Estate

Until the recent introduction of real estate futures on the Chicago Mercantile Exchange (CME), there have been few opportunities to manage house price risk. This paper examines whether house price risk can be effectively hedged in Las Vegas, one of the CME contract cities. The analysis considers hedging from the viewpoint of real estate investment groups, mortgage portfolio investors, builder/developers and individual homeowners. For investment groups and mortgage holders holding a mix of new and existing home assets, CME futures would have reduced house price risk by more than 88% over the 1994–2006 period. Similarly, homeowners implicitly hedging price volatility of existing homes also would have fared well over the sample period. However, builder/developers worried about new home price appreciation would have been much less successful in managing their risk. One important caveat, minimum variance hedge ratios change over time and may cause hedge performance to suffer.

Trading House Price Risk with Existing Futures Contracts

This paper examines the use of futures contracts to hedge residential real estate price risk. We examine whether existing futures contacts can effectively be used to offset volatility in national house prices. Little evidence of any simple systematic relation between national prices and futures prices is found. Since house prices are not easily replicated with a portfolio of existing futures contracts, a further implication is that the Chicago Mercantile’s introduction of a financial asset whose value reflects house prices will help complete the market. Nevertheless, the success of the CME’s new derivative contracts may be limited in light of state and regional house price correlations.

Determinants of House Prices: A Quantile Regression Approach

OLS regression has typically been used in housing research to determine the relationship of a particular housing characteristic with selling price. Results differ across studies, not only in terms of size of OLS coefficients and statistical significance, but sometimes in direction of effect. This study suggests that some of the observed variation in the estimated prices of housing characteristics may reflect the fact that characteristics are not priced the same across a given distribution of house prices. To examine this issue, this study uses quantile regression, with and without accounting for spatial autocorrecation, to identify the coefficients of a large set of diverse variables across different quantiles. The results show that purchasers of higher-priced homes value certain housing characteristics such as square footage and the number of bathrooms differently from buyers of lower-priced homes. Other variables such as age are also shown to vary across the distribution of house prices.

The Relative Impacts of Trails and Greenbelts on Home Price

This study examines the impacts of trails and greenbelts and other amenities on home value. Using the hedonic framework the study provides analyses of a database consisting of roughly 10,000 sales of homes occurring from April 2001 to March 2002 in and around San Antonio, Bexar County, Texas. Among other things, our study shows that trails, greenbelts, and trails with greenbelts (or greenways) are associated with roughly 2, 4, and 5%, price premiums, respectively. The following amenities: proximity to golf course, neighborhood playground, tennis court, neighborhood pool, view, and cul-de-sac, all add significantly to home value.

The Effect of Reputation and Competition on the Advice of Real Estate Agents

We study a two-period bargaining game where buyers and sellers employ real estate agents to help them determine the sales price of a house. We find that agents are less likely to provide aggressive bargaining advice to their client when they receive percentage commissions and when they work for the buyer. In addition, we find that agents are less likely to suggest aggressive bargaining strategies when there is little market competition, the gains to trade are large, in markets where housing values appreciate slowly, and when dual agency is permitted. More importantly, we show that an agent is more likely to bargain aggressively and capture a portion of the gains to trade for a client when the house’s sales price is closely related to the agent’s reputation and future business (referrals).

Do Repeated Wildfires Change Homebuyers’ Demand for Homes in High-Risk Areas? A Hedonic Analysis of the Short and Long-Term Effects of Repeated Wildfires on House Prices in Southern California

Unlike most hedonic studies that analyze the effects of a one-time event, this paper analyzes the effects of forest fires that are several years apart in a small geographical area. We find that repeated forest fires cause house prices to decrease for houses located near the fires. We test and reject the hypothesis that the house price reduction from one fire is equal to the house price reduction from a second fire. The first fire reduces house prices by about 10%, while the second fire reduces house prices by nearly 23%, a statistically significant difference. The pattern of these results are robust to several alternative econometric specifications.

Volatility Transmission in the Real Estate Spot and Forward Markets

How shocks in one market influence the returns and volatility of other markets has been an important question for portfolio managers. In the finance literature, many studies found evidence of volatility spillovers across international markets, as well as between spot and futures markets. Although real estate is often regarded as a good vehicle for diversification, the dynamics of its volatility transmission have been largely ignored. This paper provides the first study to examine volatility spillovers between the spot and forward (pre-sale) index returns of the Hong Kong real estate market through a bivariate GARCH model. Transaction-based indices were used so that our volatility modelling was free from any smoothing problem. Our results showed that real estate returns exhibited volatility clustering, and the volatility of the forward market was more sensitive to shocks than the spot market. Moreover, volatility was mainly transmitted from the forward market to the spot market, but not vice versa.

Foreclosure Sales: The Effects of Price Expectations, Volatility and Equity Losses

Where borrowers are personally liable for shortfalls when they default on their mortgages, lenders have to exercise a duty of good faith in securing a reasonable value for the foreclosed property. The lender is entitled to recover the outstanding loan as quickly as possible, and is not bound to sell the foreclosed property at the highest price. Such an institutional setting allows us to study lender and borrower behavior, specifically the influence of price expectations, volatility and equity losses on foreclosure transactions using non-foreclosure transactions as a comparison. Our results show that differences in seller response to market expectations and equity losses exist across foreclosure and non-foreclosure transactions. Seller behavior matters. While price expectations, volatility and equity losses are influential factors for individual households, past price movements is the most important. This study also further seeks to distinguish loss aversion from disposition effect. By controlling for properties that suffered losses in equity but did not sell, we are able to examine the disposition effect in house owners. The result shows that there is disposition effect for non-foreclosure properties, where individual homeowners are reluctant to sell if the properties suffer losses.

School Quality, House Prices and Liquidity

This paper develops an empirical framework for taking into account the effects of endogenous liquidity on price capitalization estimates. Changes in school attendance zones in the East Baton Rouge Parish public school district provide a natural experiment for studying how changes in school characteristics affect house prices and liquidity. House price and selling time, or liquidity, are simultaneously determined in search markets. The empirical model exploits variation in the surrounding neighborhood market conditions pertinent to each house to identify the system of price and liquidity equations. The estimates are consistent with search-market theory in that liquidity absorbs part of the capitalization of school quality.