Read James Surowiecki. Excerpt:
At a new online site called HedgeStreet, investors can bet on changes
in home prices in certain cities. And later this month the Chicago
Mercantile Exchange is going to start trading futures contracts pegged
to housing-price indexes in ten major metropolitan areas. The Chicago
plan, which is the brainchild of two economists, Karl Case, of
Wellesley, and Robert Shiller, of Yale, is straightforward: if you just
spent, say, $1.5 million on a two-bedroom apartment in Manhattan, and
you want to hedge against the risk that it might be worth $1.2 million
three years from now, you can sell contracts that will reap you a
profit if local prices fall, allowing you to lock in the current value
of your home. Alternatively, if you think the housing boom in Los
Angeles still has a ways to run–or if you’re interested in buying a
year from now but are afraid that you’ll be priced out of the
market–you can place a bet that will pay off if prices keep going up.
I’ve got to think that a “costless collar” option trade, in which the homeowner writes a covered call giving up all upside beyond $X in exchange for protecting his downside beyond $Y, is (a) both the most popular/liquid use of these indices (and derivatives thereupon) and (b) heavily skewed in favor of speculators at this point. Wouldn’t all the panicky homeowners rush to lock in home equity?
On the other hand, this allows a risk-averse homeowner to lock in a gain without having to incur the frictional transactions costs of moving house. You can always buy back your short contract at a loss (offset by the paper gain on your home) and sell a higher one, taking tax-deductible capital losses over time and never needing to move.
I think this is a market for a “strip” home security, much like a stripped T-bill. The coupons belong to someone else, who is not necessarily either the buyer or the seller of the index. In the case of a hedging resident homeowner, the home owner is both the option writer and the owner of the coupons, but conceivably a professional landlord (or developer) could “sell the coupons” by renting the dwelling for cash, and “sell the strip” in the forward market to lock in a future capital gain, which would then be accepted as collateral by a lender today.
If we consider depreciation on the house as a natural byproduct of having someone live there, which reduces the future value, a negative forward rate seems quite reasonable.
Alex, you want to subtract the y (and convenience yield?) Add depreciation & maintenance.
Shiller said that he thought the futures would settle into backwardation, although he was coming from a Keynesian hedging angle as opposed to cost-of-carry.
Does anyone have a copy of Holbrook Working’s paper on Wine Futures?
The basis risk is huge for these indices – ie, your house price moves by x. index moves by something much larger.
As for an accurate forward rate, I think you have to separate the land and build entity, after all, the land is scarce and depletable (in most cities – ex transport tech) whereas the built good is subject to depreciation and maintenance. So, a forward might look something like the following:
F=(construction cost/total cost)*Total cost*(e^(r-u)t)+(land cost/total cost)*(e^(r+y)t)
As for using these as a hedging instrument, I think you’d have to hedge a portfolio instead of just hedging single assets, homeowners and the media would have a field day oer the first person to get blown up by basis risk.
was wondering how the housing index futures are trading today and what are(s) of the country are using them most successfully. Thank you.
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