Hedging Home Equity Risk: Examination of a Nobel Idea

Robert Shiller has long advocated the use of derivative real estate instruments to manage home equity risk and address the economic inefficiencies in the housing market. His body of work in this area is literally a Nobel, if not noble, idea, having led to his being awarded economics’ most prestigious award in 2013. While Shiller carefully lays out the benefits of managing homeowner’s equity risk, to date practical issues of hedging have been largely unexplored. With the 2006 listing of real estate futures contracts on the Chicago Mercantile Exchange (CME), it is now possible to examine hedging effectiveness using the CME derivatives. In the following analysis, we examine transaction data from Las Vegas and consider a simple futures rollover strategy along with hedging strategies whose payouts are related to changes in the underlying house price index. The results indicate that idiosyncratic risk is large and renders hedging strategies ineffective for many homeowners that lost money on the sale of their house during the financial crisis. The set of results include certain holding periods where hedge payouts are only a small fraction of their home equity losses and still other times when an individual would lose both on their home sale and on their derivatives position. Thus, the evidence suggests that while the idea of home equity risk management is a Nobel idea, hedging strategies can often lead to ineffective results.